Mortgage rates' swift rise follows a sharp increase in the yield on the 10-year Treasury note, which has climbed amid expectations of higher interest rates overall as the Federal Reserve has hiked its short-term rate in a bid to crush the highest inflation in decades.
As mortgage rates rise, they can add hundreds of dollars to monthly mortgage payments. That’s a significant hurdle for many would-be homebuyers, resulting in this year’s housing downturn. Last month, sales of previously occupied U.S. homes fell for the ninth consecutive month. Annual sales are running at the slowest pre-pandemic pace in more than 10 years.
For house hunters still able to afford a home at current elevated mortgage rates, reducing their monthly payments with an adjustable-rate loan for the first few years can help give them financial flexibility.
A homebuyer who takes out a typical 5/1 ARM, for example, will have a low, fixed rate for the first five years of the loan. After that, the loan shifts to an adjustable interest rate, which could be higher or lower, until the debt is paid off, or the buyer refinances the loan.
Another approach that’s become popular recently is buying down the interest rate on a fixed-rate 30-year loan for the first two or three years.
Buying down the rate on a 30-year mortgage can make monthly payments more manageable -— something both homebuilders and homeowners are offering to entice buyers as the housing market slows.
Let’s say a borrower takes out a 30-year mortgage with a 6% fixed rate. With what’s known as a 3-2-1 rate buydown, that homebuyer’s interest rate would be 3% in the first year of the loan, 4% in the second and 5% in the third, saving them potentially thousands of dollars along the way.
The borrower must still qualify for the full monthly payment before the buydown adjustment, however.