How Home Buyers Can Adapt to New Financing Rates

When mortgage rates spiked from just under 3% at the end of 2021 to close to 7 percent in late 2022, the shock had an immediate impact on the housing market. While builders and lenders know that mortgage rates in the 5 percent to 6 percent range are historically fairly normal — and rates appear to be dropping closer to 6 percent in early 2023 — buyers preparing to purchase a newly built home faced some sticker shock. However, now that rates seem to be stabilizing, buyer demand for new construction homes continues to be strong, says Tracy Kinsinger, vice president, regional production for Tri Pointe Connect, the mortgage company affiliated with Tri Pointe Homes in Beaufort, South Carolina.

“Our approach to higher mortgage rates is to train all of our sales professionals and lenders all over the country to talk to buyers about their options,” Kinsinger says. 

Lenders and builders have many tools that can help borrowers manage their finances and buy now rather than wait for a hoped-for interest rate reduction.

“We have a financial services program that can help any buyer improve their credit score within 30 to 90 days,” Kinsinger says. “A lot of people think that because they have a good credit score of 720, they’re fine. But if we can help them get their credit score to 740 or 760, that will lower the cost of the private mortgage insurance (PMI) that they need to pay if they make a down payment of less than 20 percent. Lowering the PMI premiums makes it easier to afford a higher mortgage payment.”

Buyers can reduce the amount they borrow and eliminate PMI if they make a down payment of at least 20 percent. But making a larger down payment —such as 25 percent — won’t change the mortgage payment that substantially, says Erica Davis, branch manager at Guild Mortgage in Myrtle Beach, South Carolina.

For example, buying a $500,000 home with a 20 percent down payment of $100,000 would require a $400,000 loan and a monthly principal and interest payment of $2,398 at a mortgage rate of 6 percent. A 25 percent down payment ($125,000) would lower the monthly payment by just $150 to $2,248.

However, there are other options besides a big infusion of cash that can help buyers adapt to higher mortgage rates.

“Now that the housing market is a little less frenzied, builders are offering pre-construction sales again,” Davis says. “That gives buyers a little more flexibility than they had when there was a shortage of inventory and competition was intense.”

Buyers also have an opportunity to negotiate with builders about closing cost assistance or upgrades, with a plan to refinance when rates drop in the future, says Nicole Rueth, branch manager and senior vice president with The Rueth Team at One Trust Home Loans in Denver.

Financing Options to Manage Higher Mortgage Rates

Every buyer should consult a mortgage expert to discuss personalized alternatives for financing their purchase. Here are some options to consider:

Low Interest Rate Loans

Builders often have affiliated mortgage companies or preferred lenders that they can work with to get a better deal for their buyers, Rueth notes. For example, builders can buy a certain amount of loans at a discount upfront. “This isn’t something that’s possible for buyers or sellers to do on their own, but some builders can pay a discount fee upfront for a reduced rate on $3 million in financing and then offer that lower rate to market to buyers,” Rueth says. 

Kinsinger says there’s a psychological element to mortgage rates that can encourage buyers to look at a community when they see a low rate advertised. “If rates are around 6 percent and a builder can offer loans for less than 5 percent, such as 4.875 percent, that’s less scary to buyers,” he says. 

Temporary Rate Buydowns

Many builders offer to pay closing costs for buyers as an incentive, says Kinsinger. In response to higher rates, a number of builders also have been offering a temporary rate buydown as part of the closing costs. A temporary buydown can be for one, two, or three years. For example, with a 3/2/1 buydown, when a mortgage rate is 6 percent, the borrower would pay 3 percent interest during the first year, 4 percent during the second year, 5 percent during the third year, and 6 percent for the rest of the loan term. However, buyers must qualify based on the normal rate — in this case 6 percent, says Davis.

Permanent Rate Buydowns

On average, it takes about three years to break even on the cost of a rate buydown, says Davis. “If a builder is offering to pay for your buydown, then it absolutely makes sense to do that, but if you’re paying for it yourself, you may want to lay out all your options to see what’s best,” she says. “In some cases, it may be better to keep your cash and just make an extra loan payment once each year to reduce your overall interest payments and to pay off your loan seven years earlier.”

While a permanent buydown won’t bring the rate or payments down as dramatically as a temporary buydown, the advantage is that the lower rate is locked in for the entire loan term, says Rueth. For example, a permanent buydown might bring the rate from 6.25 percent to 5.25 percent.

“One thing to keep in mind is that there are limits depending on the loan program of how much the builder can contribute to closing costs, including costs used for a buydown,” Rueth says. “The limits range from 2 percent to 9 percent of the loan amount.”

Long-Term Rate Locks

To offset concern about what may happen with mortgage rates, many lenders offer mortgage rate locks of as long as one year, Davis says. “You’ll pay a fee, but you’ll also know what your rate will be when you close,” she says. “If the rate drops, you’re allowed to float the rate down. And the fee is part of your deposit that’s included in your closing costs.”

Adjustable-Rate Mortgages

During 2022, hybrid adjustable-rate mortgages (ARMs), which have an initial fixed-rate period followed by a rate that adjusts annually, became more popular, Kinsinger says. Typically, the initial rate will last for five, seven, or 10 years and will be lower than a 30-year fixed-rate loan. Buyers who intend to sell before the initial term is up, who expect a substantial increase in income, or who plan to pay off their loan in full may be good candidates for an ARM as long as they completely understand the terms and the highest potential mortgage rate they would face. 

Refinance Fee Waiver

Guild Mortgage and other lenders currently offer a waiver of some closing costs for a refinance within three years of a loan closing, Davis says. “That way buyers know it will be less costly to refinance if rates drop, but they can start building wealth now instead of renting,” Davis says. 

One thing to keep in mind, Rueth says, is that the market may change again depending on the movement of mortgage rates.

“Buyers have an opportunity now because of a slowdown in the housing market, but if mortgage rates dip below 5.5 percent again, demand is likely to be very strong and home prices will rise quickly again, too,” Rueth says. 

In other words, working with a lender and builder to create a financing package that works now may be a better option than waiting for the market to change.