|First: don't panic.
Mortgage rates are notoriously fickle, following the whims of the
bond market. While it's true that interest rates rise much more quickly
than they fall, even a sharp jump in one day or week can be erased
over the next week or two. The current 30-year fixed rate mortgage,
now nearing 6.5% (as we write this), still ranks among the low points
of the past several years. Plus, keep in mind that even a one-half
percent rise (from 5.5% to 6%) is only a $33/month increase for a
$100,000 loan -- and since most of your early payments are tax-deductible
interest, you'll recoup some of that on April 15.
Pay down your
ARM. If you have an ARM which will be subject to higher interest
rates in the months (or years) ahead, you can offset the at least
some of the effect of higher interest rates by having them apply
against a smaller loan balance. For example, a $100,000 5/1 Hybrid
ARM at 5% will have a remaining balance of $91,829 at the 61st month.
If the rate should rise to 6%, your payment would leap from $537
to $592. However, if you had paid down the loan by an additional
$50 per month for the first five years, your balance at the time
of adjustment would be $88,829 -- and your monthly payment would
only rise to $572. Send an extra $100 per month during that time
and your payment lifts only to $553. (Note: to keep your payment
the same at 6% as it was at 5%, you would need to have paid the
loan balance down to $83,319 -- about a $142-per-month prepayment
pace). Of course, every additional dollar in principle you send
today is one where no interest will be charged tomorrow, so don't
Consider another loan product. Today's mortgage market features
a wide array of products, from long-term fixed rate (FRM) to short
term adjustable rate (ARM). If a 6% 30-year FRM might bust your
budget, a 5/1 'Hybrid' ARM could fit the bill. These have a fixed
interest rate for the first five years at about a half-percent below
the 30-year fixed. That way, you get in at a rate you can afford
-- but after that, your rate (and payments) will change annually,
so keep an eye on rates and watch for chances to refinance into
a real FRM. Or, possibly, into another hybrid ARM; they're also
available in 3/1, 7/1, and 10/1 flavors. The longer the fixed period,
however, the lesser the interest rate savings.
What about a '2-1' buydown? Buydowns are among the oldest loan
gimmicks around. You start with an interest rate that is about two
percentage points below the market rate for the first year. After
that, the rate steps up by 1% in the second year, then rises again
by 1% a final time for the 3-30-years. The catch: The final interest
rate usually ends up about one-half percent above today's rates.
So, rather than getting 6% today, you get 4.5% in the first year,
5.5% in year two, then 6.5% for the remainder of the loan. Of course,
you could refi before that happens if rates go your way.
Pay more points to lower the rate. You can pay additional discount
points to lower the interest rate. Each point will cost you 1% of
the loan amount, so it's not a cheap option -- but each point you
pay should lower your interest rate between 1/8% and 1/4%, depending
upon the product you choose. For example: you pay two points ($2,000
on a $100K loan) to lower that 6% rate to 5.5%. You'll reduce your
payment by $32 per month, so you'll break even in about 5 years.
You'll probably need some spare cash (say, in a rainy-day fund)
to do this -- but the lender may let you instead add the cost to
the amount you're borrowing, especially if it's a refinance.
Take a shorter commitment period. One of the lesser-known facets
of mortgage pricing (rates) is that lenders offer a wide variety
of commitment periods, ranging from 30 days to 60 days and even
longer. The committment period is simply the time expected to close
the loan, and mortgage lenders often quote an "average"
one, like 45 days. If your paperwork is in order, and if your credit
record is good, you might be able to close your loan in only 30
days. As a reward, your rate will be slightly lower as a result
of the shorter commitment period. This may be worth asking about
as lenders get less busy, since closing times may be starting to
get shorter again.
Offset the rise in rates with a bigger downpayment. You can still
keep your monthly costs down if you can afford more upfront. That
$100,000 mortgage at 5.50% has a monthly payment of $567.78; with
a 6% rate, you'll only be able to borrow $94,701, hich means you'll
need to come up with an additional $6,300 to keep your payment level.
If you're cashing stocks to generate your downpayment anyway, you
might consider this option.
Get a "floatdown" option. Think rates might be lower
by the time you close, but are too afraid to let your rate really
"float"? A floatdown option may be the best of both worlds.
You can pay a small fee (one-eighth to one-quarter point is common)
to have access to lower rates if they fall during your commitment
period. Another method sets limits of how high or low your rate
can travel during the commitment period, but you may start at a
rate that is higher than market to start with (i.e. 6.125% with
a floatdown option to 5.75% versus 6% with no floatdown option).
Try a "Second Mortgage" instead. In some circumstances,
you might find a local bank, thrift or credit union offering Home
Equity Loans at very attractive rates, which you may be able to
use to replace your first mortgage. Lenders usually write these
loans for their own portfolios, meaning that there are wide ranges
of rates in most markets, so you'll need to shop around. Of course,
most equity loans aren't made with terms of 30 years, but are usually
available in 10 and 15- year flavors, so if you started with a 15-year
loan, or if you're deep into your mortgage -- more than ten years
in -- you can possibly replace your exising loan at a lower rate
or even shorten the term a little with no real rise in monthly payment.
Be wary of using a home equity line, though, especially if you think
you'll be in this mortgage for a long time. As these are variable
rate products, usually tied to the Prime rate, the prospect of higher
interest rates in the years ahead makes this a viable option for
"holding periods" of three years or less.
Consider an "Option ARM" or an "Interest-only"
payment plan. While these can and do have their risks, they are among
the few choices where borrowers have a degree of control over their
monthly payment. If a "high" fixed rate mortgage or even
a fully-amortizing Hybrid ARM brings too great a budgetary restraint,
you can select either of these payment methods and help meet your
goals. However, in order to ameliorate future risks of sharply higher
monthly payments, you should pay as much of the actual principle and
interest which are due as you possibly can. This way, your loan will
have a lower dollar amount exposed to higher rates or payment requirements
down the road.