Recent interest rate hikes have made budgeting for a home less accessible than it was in the past. Aspiring first-time homebuyers may have trouble anticipating their monthly payments since interest rates keep changing. That’s particularly true since home prices have been broadly on the rise. Couple that with the impacts of increasing consumer prices, and it’s even more difficult to determine if a mortgage fits into a budget.
Fortunately, while budgeting for a home with rising interest rates can be hard, it isn’t impossible. If you aren’t sure where to begin, here are some tips.
Gather Up a Solid Down Payment
One of the most widely touted mortgage tips is to have a sizable down payment. The main reason is that you can typically get better interest rates if your down payment is bigger, as you represent less of a risk. Plus, if you have at least 20% of the home value to put down, you can avoid private mortgage insurance (PMI), saving you money every month.
If 20% down isn’t an option, you may want to focus on mortgages without PMI. For example, VA loans don’t have PMI even if you don’t have a down payment, so military members and veterans may want to turn their attention there. However, that isn’t the only program available.
Know Your FICO Credit Score
When lenders advertise mortgage rates, they usually list numbers based on highly qualified borrowers. Often, that means homebuyers with down payments, solid incomes, low debt-to-income ratios and high credit scores.
While most homebuyers know where they sit with the first three points, not everyone knows their credit score. As a result, you want to research yours before you start exploring mortgages, allowing you to determine your odds of getting the best rate or see if you’re more likely to end up with something higher.
Fortunately, there are plenty of ways to get your FICO score. Many banks, credit unions and lenders let customers see theirs for free. Experian allows you to check your FICO score with them for free every month, too. Plus, you can pay for a one-time report from myFICO if you want to see all of your scores.
Just keep in mind that a VantageScore – the free scores you see through services like Credit Karma – isn’t the same as a FICO score. Since they’re calculated differently, the two scores can vary dramatically. Generally, lenders use FICO scores to make decisions, so you’ll want to know what your FICO score is whenever possible.
Take Advantage of Mortgage Calculators
Mortgage calculators are a great way to estimate how much you’ll need to budget. While they won’t all account for homeowner’s insurance and property taxes – both of which are usually added to your monthly mortgage payment – they do let you explore the impact of various interest rates.
Head to a mortgage calculator and run some numbers. Along with estimating what you could borrow based on the lowest rate you’d likely secure, see how the picture changes if you increase the interest rate by a full percentage point. That will help you determine if your budget could support a higher rate or if it may be wise to focus on lower-cost homes to keep this monthly expense under control.
Also, return to the mortgage calculator every time the landscape changes, such as when the Federal Reserve shifts interest rates. That allows you to stay on top of how the adjustment would impact your budget, making it easier to identify a reasonable target when it comes to home price.
Don’t Default to Your Pre-Approval Amount
When you begin exploring mortgages, a lender uses a variety of factors to determine your pre-approval amount. In some cases, they’re willing to lend far more than you expected, making it seem as if a higher-priced home is affordable.
However, that isn’t always the case. The pre-approval may not account for costs like PMI, property taxes or homeowner’s insurance, all of which can add a significant amount to your monthly payment. Additionally, it may be more than you can comfortably spend, depending on your savings routine, spending habits or other financial goals.
Don’t let a pre-approval convince you to spend more. Instead, know how much you can reasonably fit into your budget first – factoring in homeowner’s insurance, property taxes and PMI, if applicable – and use that as a guide to determine a purchase price that actually works.
Consider an Adjustable-Rate Mortgage
If you don’t intend to relocate in the next five to seven years, an adjustable-rate mortgage (ARM) could let you secure a lower interest rate now. Usually, the locked-in period lasts five years, though some ARMs come with seven or ten-year locked-in terms. Then, once that period ends, the interest rate adjusts based on conditions that exist at that time.
The most important thing to remember is you may need to refinance before the locked-in period ends if interest rates are higher. Otherwise, your mortgage payment could balloon quickly, making it hard to manage. If you’re confident your credit will be strong and you’ll have suitable income down the line, this is an approach that’s worth considering.
Wait Until Interest Rates Decline
Mortgage rates have been on the rise due to inflation. When inflation occurs, the Federal Reserve usually raises rates as a means of rebalancing the economy. However, once inflation ends, rates may head in the other direction. That’s particularly true if deflation becomes a concern.
The same can be true of home prices. They’ve been climbing quickly for several years, but that rate of growth may be unsustainable. If things stabilize, homeownership may become more affordable.
While there’s no guarantee whether rates or home prices will keep climbing for months or years, they won’t go up forever. If you’re genuinely struggling with fitting a mortgage payment in your budget now, waiting may be your best choice. Then, you can continue saving up a down payment instead of making a purchase that could financially backfire, ensuring you’re in a more comfortable position when you do choose to make the leap.
