Creative Mortgages in Times of High Interest Rates
Today’s higher interest rates are squeezing would-be home buyers. Less than three years ago, rates were below 4 percent. Now they are near seven, and monthly payments have soared. This has driven home sales down and generated fresh interest in creative financing programs. If you’re in the market for a home, consider these alternatives to a standard fixed-rate mortgage.
Interest rate buy-downs
Home sellers and new home builders may offer interest rate buy-down incentives, which lower the buyer’s interest rate for an initial loan period. In this scenario, the seller or builder makes a price concession to provide the buyer the funds to “buy down” the mortgage interest rate. The rate is tiered over the first few years. For example, in a 2-1 buy down on a $300,000 mortgage at 7 percent, the rate may be lowered to 5 percent for the first year of the loan, then 6 percent for the second year. After that, the loan settles in at the market rate of 7 percent for the rest of the loan. The buyers’ hope is that interest rates will fall during the buy-down period, and they can refinance at long-term lower rates.
With an adjustable-rate mortgage (ARM), the borrower’s interest rate remains fixed for an initial number of years, then adjusts each year. The most common example is the 5/1 ARM, in which the borrower’s rate is fixed for the first five years at a lower-than-market rate. After that, the rate may change each year for the life of the loan. The loan will have caps on the maximum amount the interest rate can adjust up or down in the initial year after the fixed period as well as year to year. Sometimes there is also a lifetime maximum upward cap.
The hope is that market interest rates will fall again, and the buyer can refinance at permanent lower rates after the initial rate adjusts. Buyers should study the loan terms carefully to ensure they are financially prepared for increases after the fixed period. ARMs can also be worth a look if the buyer intends to sell before the adjustable rate period begins.
ARMs are now offered with longer fixed periods of seven and even ten years.
Buyers can assume a seller’s government-backed loan, such as with FHA-, VA– or USDA-backed loans. The buyer assumes the loan after qualifying for the same terms as the seller’s loan. For buyers concerned with today’s high interest rates, assuming a loan taken during the period of 3 to 4 percent rates is attractive.
One challenge arises when the purchase price exceeds the assumed loan amount. To cover the difference to the seller, the buyer must pay cash or take a second loan. The second mortgage will be at current rates unless the buyer gets a loan with buy-down or adjustable-rate features.