Confused by the New Mortgage Gimmicks? Here’s a Guide.
The new math is unforgiving: At 6.7 percent, the average 30-year fixed-rate mortgage has more than doubled in less than a year, scaring away many would-be home buyers. Inflation hasn’t helped either.
Now, lenders are getting creative, offering more options to lure buyers and undercut the competition. Before the Federal Reserve began raising its key interest rate — which influences mortgage pricing — it was easy to find a mortgage that began with a 3.
Rocket Mortgage, the nation’s largest lender, recently introduced its Inflation Buster program, which promises to cut a borrower’s interest rate by one percentage point on a fixed-rate loan for the first year. Mortgages with even longer teaser-rate periods are also making a comeback. And some lenders, like United Wholesale Mortgage, which, as the third-largest, works with independent mortgage brokers, have dropped their rates.
Even interest-only mortgages, which allow borrowers to pay only interest for a set period, have returned for some qualified buyers. These loans gained notoriety during the financial crisis of 2008, after they had allowed borrowers to buy homes they couldn’t afford. They are now subject to stricter regulations.
“Lenders are scrambling to keep up market share and keep business coming through the door,” said Guy Cecala, the executive chairman of Inside Mortgage Finance, which tracks the mortgage industry. Mr. Cecala expects to see lenders — especially lenders that are not banks, like Rocket and United Wholesale — compete much more fiercely on price.
“The big banks seem content to let the non-banks duke it out for business and are willing to let their mortgage volume and market shares slip,” he said.
With refinancing activity plunging, total mortgage origination volume dropped 41 percent, to $1.38 trillion, in the first half of this year compared with the same period in 2021, according to data from Mr. Cecala’s firm. Mortgages for home purchases fell only about 5 percent, to $812 billion, over the same period.
Sky-high home prices, which rose nearly 45 percent between December 2019 and July, have already hurt prospective home buyers. Spiraling interest rates, at least relative to recent history, have made affordability an even more acute problem, with some would-be buyers no longer qualifying for a specific loan size from one month to the next.
“When rates have almost doubled in eight months, you are talking about a situation where every penny matters, and it affects people’s ability to qualify, at least for a certain amount, so the stakes are higher” for buyers, said Mark Maimon, a senior vice president at NJ Lenders.
Karen Lopez, an area manager with Americasa Home Loans, a unit of Nationwide Mortgage that focuses on Spanish speakers, had a client who recently had to renew her mortgage preapproval using the latest rate. The loan amount she qualified for dropped by $40,000 compared with six months earlier, when rates were below 4 percent.
“We knew rates were going to go up, but we couldn’t comprehend how they went up in such a drastic fashion,” Ms. Lopez said.
Many buyers are therefore making new calculations, including whether it’s worth paying upfront fees in exchange for a lower rate, or if an adjustable-rate mortgage is worth the risk. Comparison shopping — always wise for one of the largest, most complex purchases you’ll ever make — has become increasingly important.
Here’s a closer look at what’s being offered.
Temporary Rate Buydown
The latest offering by Rocket Mortgage is called a temporary buydown, which provides a lower introductory rate on fixed mortgages for the first year; after that, it bounces back to the original mortgage rate. (And buyers must qualify using the higher rate.)
Bill Banfield, the executive vice president of capital markets at Rocket Mortgage, said the offer was being treated as an expense to the company. “There is no catch,” he said. “The inflation buster was specifically designed to give clients confidence and have some relief on the payment side and deal with inflation.” (It will be available through the end of the year.)
On a $400,000 mortgage with a 30-year fixed-rate of 6.5 percent, the temporary rate would drop to 5.5 percent for the first year. That would save the borrower roughly $257 a month, or $3,084 in the first year. After that, the payment would return to the underlying rate, costing $2,528 monthly.
These temporary buydowns can take other forms — including a teaser rate for the first two years — but somebody has to cover the cost. That’s why they tend to work best when home buyers use them as a negotiation tactic, and ask the seller to pay for the buydown instead of lowering the price of the home, for example.
More home buyers are contemplating whether it’s worth paying an upfront fee, which allows you to lock in a lower interest rate.
These fees are known as mortgage points, or discount points, and they often show up alongside a mortgage rate quote. Typically, one point equals 1 percent of the mortgage amount, paid to the lender to lower the mortgage rate.
For example, the average rate on a 30-year fixed-rate mortgage was 6.7 percent as of Sept. 29. But that includes 0.9 points, or a fee of $3,150 on a $350,000 loan. If you didn’t want to pay any points, the rate might have been closer to 6.74 percent, according to Freddie Mac. (That compares with a rate of 3.01 percent, or 0.7 points, for the same loan a year ago.)
Buyers who expect to be in their home for many years may feel more comfortable paying points to lower their rate. The alternative is to take the higher rate, and then refinance if and when mortgage rates fall. After all, some studies have shown that paying fees — at least for people with excellent credit and large down payments — doesn’t always result in a meaningfully lower rate.
That’s why it’s so important to shop around. There are also online calculators that can help assess whether it’s worth paying points given your circumstances. “You basically want to look at what the break-even point is,” said Mr. Maimon. “How long does it take before your cumulative monthly savings equal the cost of the points you paid? And will you still hold the loan or property at that time?”
Or you can ask the home seller to pay here, too, as part of the negotiation process.
“It’s usually cheaper for a seller to pay the points for the buyer than it would be for them to reduce the price by an amount that would give the buyer an equivalent lower payment, like the buydown would,” Mr. Maimon added. “It’s a tactic to meet halfway in a negotiation.”
More people are turning to adjustable-rate mortgages, or ARMs, which start out with a lower, fixed rate for a set period — say, five or 10 years — and then adjust to a variable rate. That makes them riskier, but it appears to be a risk more people are willing to take. As of Sept. 9, nearly 11 percent of mortgage locks — that is, when applicants lock in a particular rate — were for ARMs, up from 2.5 percent a year earlier, according to Black Knight, a data firm that tracks the mortgage market.
The average rate on a five-year ARM was 5.3 percent (with a fee of 0.4 percent of the mortgage amount), or more than a full percentage point below the average rate of 6.7 percent on a 30-year fixed loan (with 0.9 points) for the week ending Sept. 29, according to Freddie Mac. On a $400,000 loan, that’s $360 in monthly savings.
A longer fixed period is a safer bet, giving borrowers more time to accommodate their life plans before the loan resets at the higher, variable rate. It also means that rates could fall enough that it would make sense for a buyer to refinance to a fixed-rate loan.
Interest-only loans work just as they sound. Borrowers pay only interest for a set period, usually up to 10 years, resulting in a lower monthly payment. After that, the payments jump because they include both interest and principal, just as a typical mortgage does, except over a shorter remaining term. But, because these are typically structured as adjustable-rate mortgages, the rate is fixed during the interest-only period and variable thereafter.
Such loans become especially dangerous when they are used to buy a home that would otherwise be out of reach for a buyer, which is exactly what happened during the run-up to the financial crisis. Borrowers piled into these and other risky loans, and when the housing market plunged, many people were left holding mortgages worth more than their properties, and with payments that they could no longer afford.
Now, these loans are largely used by more affluent homeowners to manage their cash flow, giving them the flexibility to pay down principal when they receive cash from a bonus or a commission, for example.
Get a Loan Estimate
It is challenging to make apples-to-apples comparisons when shopping for a mortgage given the points and fees charged in addition to the underlying rate, but there are a few ways to make it easier. If you want to get quotes from three lenders, you’ll need to clear enough time to make the inquiries on the same day. If you spread them out over several days, rates may change.
One quick way to compare rates across providers is to look at the mortgage’s annual percentage rate, which includes the interest rate, points and any other fees or charges.
All lenders are required to provide a standardized loan estimate after you provide them with key pieces of information, including the property address, its estimated value and the desired loan amount. You don’t have to provide documentation to prove any of this before receiving the loan estimate, according to the Consumer Financial Protection Bureau.
But the agency does encourage borrowers to take those extra steps to receive a formal quote instead of getting only a rough sketch, since that will make it easier to compare offers, which is even more important to do now.