Tips for rising interest rate markets

By William Kugel

Within a relatively short period of time we have recently seen some signs that spur concerns over rising interest rates for mortgages. Even though the most recent actions and testimony of Alan Greenspan on behalf of the Federal Reserve state that the Fed stands ready to keep interest rates low, rates for long-term mortgages have spiked even if ever so slightly. This should not come as a huge surprise as the chief economist for Fannie Mae even announced at the beginning of the year that mortgage rates would begin inching higher in the second half of the year. Most analysts believe that rates will move slightly higher but remain near their 45-year lows for some time. However, even small increases in rates are likely to have their effect on refinances as well as potentially impacting purchases just because of perceptions and the psychology of a rising interest rate environment.A market like this is accurately described as "volatile", up one day and down the next. Such markets tend to create uncertainty and confusion. Many consumers tend to move to the sidelines until the dust settles. Others tend to flood into the market fearful that rates will get away from them before they accomplish their objective. The reason for the volatility stems from the market's inability to forecast how close or how far our economy is from recovery. One week the indicators suggest a recovery sooner than later. Low rates have been in place due to a forecast that views the economy has been in a freefall or facing a very slow recovery. As economic indicators are released that show signs of more robust retail sales, shrinking inventories, and increased productivity, the long term rates get pegged at higher rates consistent with higher demand. Wall Street is basically focusing on a reality that higher interest rates are probably inevitable. Yet evidence of the recovery process is still very tenuous. How can mortgage customers best cope with these uncertainties? While these kind of economic conditions present challenges to prospective borrowers, this is not a totally impossible situation either. Here are some suggestions to keep in mind if entering the mortgage market when interest rates are clearly shown to be on the rise:1. Rely on real numbers. Rising interest rates can and often do trigger fear and dampen sales. The facts generally reduce fear. Using actual numbers tends to put things in a truer perspective. When armed with the actual payment and/or the increased cost, many people will continue on with their intention to purchase a home. For example, a rate increase of 1/4 percent on a 30-year mortgage loan of $80,000 increases the monthly payment by approximately $14.00 per month. Many purchasers will not abandon their goal of homeownership even with much larger increases. 2. Pay more attention to the length of time you expect to keep your next mortgage. The single most important question I ask prospective borrowers is "how long do expect to hold this loan?" The answer is the key to picking the right type of loan and deciding whether or not to buy your interest rate down with discount points. Keep in mind that the answer may or may not be the length of time you plan to own the property. For example, many people will buy a property for one use now and then later it becomes a rental property. In such cases you may have the loan for longer than the time you will actually live in the property or use it as a vacation home.3. Give more thought to locking in your rate at time of application. The value of locking in a rate becomes most useful when rates are expected to rise during the time your transaction is being processed and closed. While it appears we may have already hit the low point for mortgage interest rates in this economic cycle, it is probably still too early to presume that rates will do nothing else but rise continuously.4. Give more thought before opting to pay points. Chances are that you will be less likely to keep your new mortgage a long time when locking-in with a higher rate. Paying points is a decision you should arrive at only after answering the question of how long you expect to keep the loan AND doing the math on the potential savings over that period of time versus the additional cost. If you calculate the time it will take to break even with the cost of paying a point (typically about 5 years for a 30-year mortgage) and cannot forecast at least an equal amount of time to make a profit, the benefits of paying points are marginal.5. Consider loan programs with shorter terms. If you are someone who can more reliably predict that you will either refinance or sell within a short period (less than seven years), then you will benefit with an adjustable or short-term fixed rate mortgage. These products offer lower interest rates over the shorter period you expect to use the loan. If contemplating an adjustable mortgage, conversion options deserve closer scrutiny. 6. Seek out lenders who make it easier to shift gears when rates come down. Some lenders make it easy for their existing customers to roll down their rates with streamlined guidelines for refinancing when the opportunity presents itself. Some lenders do away with the need for an appraisal and/or updated income and asset documentation. Such a feature will allow you to avoid costly points now and pick up a lower rate in the future.As you have read, there are strategies that are more applicable in rising interest rate environments. If you use real numbers, keep things in their actual perspective, give more thought to your choices, and seek out programs and lenders with flexibility, you can prudently proceed in upwardly mobile markets. Also keep in mind that with any signs of a slow down in the economy and in particular the housing market, it is still possible to see interest rates recede a little again. Finally, historically and statistically mortgage rates more often than not do not follow suit with Federal Reserve announcements. It is easy to fall prey to misinformation or make untrue assumptions. Your best bet is to take the time to consult with mortgage and financial professionals. William Kugel is author of the column MORTGAGE$ in publication for 13 years, a senior loan officer with GMAC Mortgage Corp., and a Mount Washington Valley resident. You may write him c/o of The Conway Daily Sun, visit the Web site www.gmacm.net/william_kugel or send e-mail to william_kugel@gmacm.com.All Rights Reserved. Copyright 2003, W.H. Kugel.