Marry Your Home, Date Your Rate

Higher mortgage rates haven’t stopped some buyers from taking the buy now, refinance later approach. But how do you make sure you’re not getting in over your head?

When mortgage rates doubled in 2022, many prospective buyers dropped out of the market because they couldn’t afford the higher payments. The principal and interest payments on a $400,000 loan jumped from $1,686 at 3% in early 2022 to $2,528 at 6.5% by the end of the year.

But some buyers choose to go ahead and buy even when rates creep up, anticipating that they can refinance in the future. But is “marry your house, date your rate” the right approach?

“Not the best attitude to have,” says Sara Conover, assistant manager of the mortgage department for the Philadelphia Federal Credit Union (PFCU). “The possibility of a lower rate in the future is there, but not guaranteed. You don’t want to get in over your head assuming rates will decrease in the future.”

But Steve Adamo. president of national retail production for Embrace Home Loans in Middletown, R.I., disagrees.

“It does make sense to ‘date your rate’ if you believe, as I do, that rates will come back down,” Adamo says. “Borrowers have historically been opportunistic about refinancing, and I believe this will continue over the next couple of years as well.”

Of course, betting on where mortgage rates will be in a few years isn’t a sure thing. So, it’s important to make some smart decisions just in case the “what if” of rates goes the wrong way.

When to Wait to Buy a House

The choice to buy a house is always highly individual and depends on both personal and financial circumstances. Sometimes, it’s smart to wait.

“The biggest reason a consumer should wait to purchase is if their current financial situation isn’t ideal,” says Pete Boomer, executive vice president of mortgages for PNC Bank in Hinsdale, Ill. “Are they expecting a sizeable commission check in the near future? Will they be inheriting some extra money that could make a difference in their potential down payment? Could their credit score use some improvement? It’s important for consumers to work with a mortgage loan officer, take a holistic view of their finances and determine what they can afford.”

On the other hand, if you buy now, you start building equity immediately and avoid potential mortgage rate increases, says Boomer.

“If you don’t have enough funds saved for a down payment and the closing costs, we recommend waiting until you do,” says Regina Carolan, vice president of lending for PFCU. “Also, if you are pre-approved for a certain monthly payment but your budget and the numbers are not working out, don’t convince yourself you can afford it. Save more and reapply down the road.”

In addition, Conover recommends keeping savings of three months of mortgage payments on top of the cash you need for closing costs and your down payment.

How to Avoid Getting in over Your Head

There are several mathematical equations that can help you decide how much to borrow and to prevent you from becoming house-poor.

“A lot of lenders like to talk about ‘what you can afford’ rather than ‘what are you comfortable with?’,” says Boomer. “To determine what you can afford to pay on a monthly mortgage, the 25% rule is a good start, although this does vary. This rule means that someone should spend no more than 25% of their monthly take-home pay on a mortgage payment. That being said, there are a lot of lifestyle factors that come into play and need to be considered.” 

Generally, says Conover, the maximum debt-to-income ratio lenders allow is 43%, which means that your monthly debt payments for things like your car, student loans, credit cards and mortgage equal 43% or less of your gross monthly income. 

For example, Conover says, if your gross income is $6,000 per month and you have existing debts of $1,550 plus a proposed new mortgage of $1,000 (a total of $2,550), your debt-to-income ratio would be 42.5%. If you want to borrow more to buy a house, you may need to pay down other debt first.

Home Refinance Options

The “marry your house, date your rate” concept depends on refinancing when mortgage rates hopefully dip. But you need to be prepared to refinance by keeping your debt low and your credit score high so you can qualify for a new loan. You also need to know when to refinance.

“Many borrowers find value in a refinance with a rate reduction of .50% or greater,” says Adamo. “A mortgage lender can regularly review a borrower’s financial situation.”

 Keep in mind that refinancing usually costs 3% to 5% of the loan amount, says Conover, but those costs can often be rolled into the new loan. Be aware that refinancing from one 30-year fixed-rate loan into another 30-year fixed-rate loan could result in paying more interest over the life of the loan depending on the difference in the mortgage rate and how many payments you’ve made. A lender can compare monthly payments and the full cost of the loan under several scenarios before you refinance.

“If there are no costs and you’re saving money without adding time to your mortgage, it’s a great time to refinance,” says Boomer.

Opportunities for a Lower Rate Now

While you’re waiting for mortgage rates to drop so you can refinance and lock in a lower interest rate, there are some options that can help you pay less now.

Some possibilities include:

•   Buy down your rate. Seller-paid buydowns are popular with homeowners and builders right now, Adamo says, especially a “2/1 buydown.” In that case, the sellers pay a fee at the closing to lower your rate by 2% during the first year and by 1% for the second year before returning to the original rate. For example, if your rate is 6%, you would pay 4% the first year, 5% the second year and then 6% until you sell or refinance.

“A buydown temporarily lowers a consumer’s mortgage interest rate – saving them money and lowering their monthly loan payments during the initial buydown term,” Boomer says. “However, once the buydown rate ends, a consumers’ monthly mortgage payments may be higher than expected.”

Borrowers must qualify based on the market rate, not the temporary rate. Another option is for buyers to pay a fee to buy down their rate for the entire loan period by paying discount points equal to 1% of the loan amount. Typically, one point will lower your rate by 0.25%. For  example, on a $400,000 loan, $4,000 would lower your rate by 0.25% and $8,000 would lower your rate permanently by 0.5%.

•   Make a bigger down payment. If you can afford a large down payment, such as 20% of the home price, you’ll avoid paying private mortgage insurance and have smaller payments because of the lower loan balance, says Boomer.

“However, large down payments make some consumers ‘house poor,’ meaning they won’t have cash reserves for potential emergencies, house maintenance, and new home purchases like furniture and renovations.” Boomer says.

Ideally, you’ll have 30% of a home’s value saved before you buy, with 20% for a down payment and 10% for closing costs, savings and extra expenses for your first year in the home, says Carolan.

•   Borrow with an adjustable-rate mortgage. An adjustable-rate mortgage (ARM) is a home loan that originates with a lower interest rate for 5 to 10 years, followed by periodic rate adjustments, Boomer explains. For example, a 7/1 ARM would have a fixed-rate for 7 years that is lower than a 30-year fixed-rate, and then adjust annually depending on market rates.

“An ARM can be a good idea if you’re likely to move or sell in the next few years,” Boomer says. “You can use the ARM’s fixed-rate period and sell the property before the less-predictable adjustable phases start. If interest rates rise, some consumers may struggle to make larger payments for the remainder of the loan’s lifetime.”

Many different ARMs are available, so it’s important to understand the complete terms of the loan and the worse case scenario for how high your interest rate and payments could increase.

An ARM can be refinanced into a fixed-rate loan if rates drop, says Carolan. You would still need to qualify and pay refinancing costs, however.

• Check out first-time homebuyer programs . First time homebuyers may be eligible for loan discounts or grants if they take a homeowner’s counseling course from a certified housing agency, says Conover. 

If you’re ready to commit to a house but don’t love the mortgage rate, consult a lender to discuss your options for a better rate now and refinancing in the future.