In June, the Federal Reserve confirmed that as the economy continued to improve, it would begin to wind down its purchase of mortgage-backed securities, a program designed to support the housing market by keeping mortgage interest rates low. Reacting to the Fed's announcement, the average for a 30-year fixed-rate mortgage shot up to nearly 4.5% -- almost a point higher than six weeks earlier. But that's still historically low, and as the markets settle, rates should go back down a bit. Kiplinger expects the 30-year loan rate to be 4.25% by year-end.
If you need a mortgage, lock in the best rate you can get now, and don't worry about having missed out on the lowest-ever rates. "Remember that a good, normal, 30-year fixed rate is 5%, but nobody wants to hear that when they've seen 3.5%," says Guy Cecala, publisher of Inside Mortgage Finance.
Plus, even in places with double-digit increases in home prices, values still haven't returned to the housing market's peak nationally in 2006. With a national median home price of $200,000 in the second quarter of 2013, home prices are still 34% below their crest, reports Clear Capital, a real estate data provider. And homes are still affordable throughout most of the country, except for high-priced coastal California and the D.C.-to-Boston corridor, according to a home-value and interest-rate analysis by Freddie Mac. Freddie Mac said recently that mortgage rates would have to rise to nearly 7% before the median-priced home in the U.S. would be unaffordable to a family making the median income in most parts of the country.
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Still, buyers who were on the edge of qualifying for a home may have to rethink their options. Monthly payments (of principal and interest) on a $200,000 mortgage at 3.5% are $898. At 4.5%, payments are $1,013. As rates rise, you could put off your home purchase until you see rates fall, but that's a risky proposition if home prices rise in the meantime. If qualifying for a larger monthly mortgage payment isn't in the cards, then you have a few alternatives: You can choose a less expensive home or increase your down payment to reduce the size of your loan. You can pay more points (one point equals 1% of the loan amount) to buy down your rate with prepaid interest. Or you can take out an adjustable-rate mortgage with a lower starting interest rate.
The ARM option. Adjustable-rate mortgages earned a bad reputation during the housing bust because of risky features -- super-low teaser rates and super-high rate adjustments -- that no longer exist. Today, a hybrid ARM (the interest rate is fixed for a number of years and adjusts annually thereafter) is a safer choice.
Choose one with an initial fixed-rate period that matches how long you expect to remain in the home or keep the mortgage. In late June, the average rate nationally was 3.2% for a 3/1 ARM that adjusts after three years, 3.37% for a 5/1 ARM and 3.89% for a 7/1 ARM, according to HSH.com, a rate-tracking service. Also, consider what the payment would be if the interest rate rises to the maximum allowed at the first adjustment (often to a cap of two percentage points).
Many credit unions offer a 5/5 ARM. The starting interest rate remains the same for five years, then adjusts (typically with a cap of two points) every five years thereafter. At Navy Federal, for example, the initial interest rate on its 5/5 ARM in early July was 2.375%. In five years it could adjust to 4.375%, just slightly more than the average 30-year fixed rate at the time of origination.
To help relieve rate anxiety, you can lock in your mortgage rate until you close. The longer the lock-in period (typically 30, 45, 60 or 90 days), the greater the cost -- generally an eighth of a percentage point for every 15 days beyond an initial 30 days. Some lenders offer a free, one-time "float down" feature if rates decrease before closing; others will charge a fee, for example, of an additional 0.125 point on your rate.