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Don’t rely on mortgage rates to tell you when to buy
Knowing the right time to shop around for a mortgage can be tricky. Your personal finances, a competitive market and finding the right home are all huge factors.
Many people let interest rates guide them, either rushing to buy when interest rates are down or holding off when interest rates go up. But that may not be a good idea.
We reached out to a panel of experts, and the consensus was that you shouldn’t base buying decisions on the interest rate you can get on a mortgage. According to Brian Davis, founder of Spark Rental, “Markets are unpredictable, and if you sit around waiting for them to crash before you buy, you might wait years. Even when the crash comes, its low pricing point could still be higher than today’s pricing. And that assumes you buy at the perfect trough point, which you won’t. Instead, buy based on your personal needs.”
How are mortgage rates trending in August?
According to Freddie Mac, the 30-year fixed rate has risen slightly to 6.90%, and the rate on a 15-year fixed-rate mortgage is 6.25% as of August 3, 2023. That’s almost a 2% increase from August of 2022, when the 30-year average rate was 4.99%. While many factors affect rate changes over time, the US Federal Reserve is indicating it may not raise the federal funding rate in September, which may help to keep mortgage rates steady for the next quarter as well. Mortgage experts, such as Freddie Mac, Fannie Mae, Redfin, and the Mortgage Bankers Association, predict that mortgage rates should decline to a range of 6.1% to 6.4% by the end of the year.
How are mortgage rates calculated?
Interest on mortgages is generally paid monthly, which means you can divide the annual interest rate by 12. For example, if you took out a mortgage of $600,000 at 6.5% interest over 30 years, you’d usually pay a monthly rate of 0.54%* — interest on your principal.
For the first repayment, you would pay $3,240 interest plus principal. Each consecutive month, the principal would be less, meaning you’ll pay less interest.
*Be sure to check with your lender for more information on how your interest is paid over the life of your loan.
What are the different mortgage rate types?
If you’re ready to start looking for your new home, explore the types of mortgages out there and see what works best for you. The most common are the adjustable-rate mortgage (ARM) and the fixed-rate mortgage.
1. Fixed-rate mortgage
A fixed-rate mortgage is the most common mortgage, with an interest rate that stays the same for the life of the loan. This means that both the payment amounts and the loan term — usually 10, 15 or 30 years — are fixed. With a fixed-rate mortgage, you have the security and peace of mind knowing what your payments will be each month, allowing you to budget more effectively. These rates can often be higher than the ones offered for ARMs, but you won’t be living with the uncertainty of fluctuating interest rates.
Fixed rate mortgages
2. Adjustable-rate mortgage (ARM)
Also known as a variable rate mortgage, an ARM is a home loan with an interest rate that fluctuates based on market interest rates. This may seem like an attractive offer, but because your interest rate is not fixed, you’re taking on some uncertainty in knowing exactly how much you’ll pay each month over the life of your loan.
Adjustable rate mortgages (ARM)
3. Hybrid adjustable-rate mortgage (ARM)
A hybrid ARM combines the uncertainty of an adjustable-rate mortgage with the predictability of a fixed-rate mortgage. A lender will offer a hybrid ARM with an initial fixed interest rate for a certain time — meaning your rates stay the same for five, seven, 10 or 15 years. Once that time is up, your rate will change based on the market rates and stay that way for six months or a year. If you have poor credit, this may be the only mortgage you qualify for.
Hybrid ARMs look like this:
- 5/1 ARM: First change after five years, then adjusts every year.
- 5/6 ARM: First change after five years, then adjusts every six months.
- 7/1 ARM: First change after seven years, then adjusts every year.
- 10/1 ARM: First change after 10 years, then adjusts every year.
- 15/15 ARM: First and only change after 15 years.
4. Interest-only mortgage
If you take out an interest-only mortgage, you’ll pay only the interest on the loan over five to 10 years and none of the actual loan amount. When the term is up, you can either pay the principal or convert it to an interest-and-principal loan (amortized) for the remaining life of the loan.
So, if you had a 30-year mortgage and the first 15 years were interest-only, the principal balance would be amortized for the remaining 15 years.
People opt for interest-only loans because it allows for a lower payment in the first few years of the loan, giving you more money for things like monthly bills or furnishing or improving your home. However, interest-only mortgages are riskier for lenders, often strapping you with higher interest rates.
5. Negative amortization mortgage (NegAm)
If you decide on a NegAm, you’ll make smaller payments each month, paying only the principal amount — not the interest. But that doesn’t mean you’re off the hook. That interest you didn’t pay gets tacked on to the total amount you borrowed — and it’s subject to interest. So you’ll be paying interest on interest.
A NegAm could give you money upfront and giving you a reliable monthly payment, but beware. If the interest rates rise, the equity in your house will decline. And instead of paying down your debt with each mortgage payment, you’re actually adding to it.
6. Balloon payment mortgage
Balloon payment mortgages are when a lender gives you a lower interest rate and monthly payments for the loan’s term — usually five or seven years. When that term is up, you pay the remaining balance. It’s called a “balloon” payment because the size of that payment is often quite large.
These loans can benefit you if you’re sure your financial situation will improve or you plan on selling the property in a few years — before your term is up. But balloon payment mortgages are risky. They were popular before the mortgage crisis in 2008 and caused many to default.
Conforming vs. nonconforming mortgages
Conforming loans usually come with lower interest rates and lower fees. These loans need to meet standards set by the government-sponsored agencies Fannie Mae and Freddie Mac. Limits can vary according to the housing market, but they’re usually less than $424,100 in most areas.
So if you want to purchase a home under the loan limit, you’ll be more likely to qualify. You’ll also have lower interest rates and may be able to make a lower down payment.
Nonconforming loans are loans that do not meet conforming loan standards. Borrowers most often see these in the form of jumbo loans. Because these tend to be a higher risk for the lender, they come with high interest rates, require a higher down payment and require a closer look at your credit before you can qualify.
Which mortgage lender should I choose?
Finding lenders with low mortgage rates is an important part of the process but shouldn’t be the only consideration. Before applying, learn more by reading mortgage lender reviews and ask the lenders questions about their processes and fees.
Once you’re ready to start the homebuying process, make sure you understand the loans you qualify for. Knowing the basics and gathering information on the front end can give you a leg up with the lender and could save you money and struggles down the road.
Common questions about mortgages
Do I need great credit to get a mortgage?
While good credit helps anytime you apply for a loan, you may not be rejected if you have a low credit score. FHA mortgages can be expensive, but you can get a high interest rate with a credit score in the 500s.
How much of a down payment do I need?
Put down as little as 3% with a conventional loan. When you apply for FHA loans, you can put down as little as 3.5%. However, if you put down less than 20% of the home’s sale price, you’ll have to pay private mortgage insurance (PMI), which you’ll pay until the loan-to-value ratio on your loan drops to 78%.
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