How homebuyers can outmaneuver peak interest rates

Thirty-year mortgage interest rates have topped 5.3% — one of the highest in a decade — resulting in a more challenging purchasing environment for homebuyers.

Mortgage interest rates, the amount charged for taking out a loan, are edging up primarily because the Federal Reserve increased interest rates three times this year to tamp down inflation. Higher Fed rates translate into higher mortgage rates. And higher mortgage rates mean steeper monthly payments for homebuyers.

In turn, higher monthly payments affect how much financing homebuyers can attain, setting a parameter on how expensive a house they can buy. Banks qualify homebuyers in part by their debt-to-income ratio, monthly payments divided by gross monthly income. The debt-to-income ratio calculation gauges the buyer’s ability to repay the money borrowed from the bank. A low debt-to-income ratio results in a better mortgage rate and higher financing.

To mitigate the impact of higher mortgage rates, homebuyers should:

Bring down debt-to-income ratio. Create a plan to bring down your debt, like paying off credit cards, cutting out nonessential spending and developing a budget. Ideally, the debt ratio should be approximately 45% to secure the best interest rate possible.

Clean up credit issues. A credit score of 740 or better will help homebuyers secure the most competitive interest rate. Credit.com recommends pulling credit reports, going through them line by line, challenging errors, getting past-due accounts off your report, taking care of outstanding collections and using less credit.

Save more money. Putting down at least 20% of the home value or more will give you the best possible interest rate.

Opt for conventional financing. Conventional financing typically offers more flexibility and latitude than FHA and VA programs.

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Consider a 15-year mortgage. Shorter-term mortgages typically will qualify buyers for lower interest rates but remember this will result in a higher payment at the term of your loan will cut in half.

Work with a mortgage broker who can research and recommend the best lender for each situation.

Buydown your interest rate. A rate buydown is an upfront payment that reduces your interest rate and your monthly mortgage payments. This option is appropriate if you stay in the home long enough to recoup cost of the points.

Consider a temporary interest rate buydown. This means you buy the rate down for only the first one or two years of the loan, after that, it goes back to the original rate for the next 30 years. This is a great option because if rates come back down you will end up refinancing before your payment goes back up.

Buy now before rate increase again. If you’ve found that perfect home, consider locking in a rate and purchasing it now.

The bottom line is that rising interest rates make homes more expensive for buyers. They reduce buying power by 9% to 11%, pending their debt-to-income ratio. Buyers should do all they can to ameliorate the impact of high rates, starting with being aware of all the options available to them.

Whitney Dutton is owner of The Dutton Group@Re/Max First, a full-service residential real estate group, in downtown Fort Lauderdale. Call 954-440-2333 or email Sales@WhitneyDutton.com.

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