Buying a home when interest rates are high means you’ll pay more for your mortgage. You can’t control what market conditions will be like when you’re finally ready to become a homeowner, but higher interest rates don’t need to stop you from buying. In fact, there can be advantages to purchasing a home at those times.
Here’s what you need to know about buying a home when mortgage rates are high:
- How Mortgage Interest Rates Work
- Benefits of Buying a Home When Interest Rates Are High
- Disadvantages of Buying a Home When Interest Rates Are High
- Alternative Financing Options When Interest Rates Are High
- The Risks of Trying To Time the Mortgage Market
- Should You Buy When Interest Rates Are High?
- FAQ: Buying a Home When Mortgage Rates Are High
- The Bottom Line on Buying When Interest Rates Are High
How Mortgage Interest Rates Work
The interest rate on your mortgage represents how much it costs per year to borrow the money for your home loan, and is expressed as a percentage rate. It doesn’t include the fees you pay to get the loan. The rate you’re offered is based in part on information like your credit score and down payment, but it’s also tied to market conditions.
The central bank of the United States, known as the Federal Reserve, sets monetary policy depending on the strength of the economy. While the Fed doesn’t dictate the interest rates charged by lenders, it influences them through the target federal funds rate. If the market needs a boost, the Fed can lower its target rate and make borrowing money easier. But if inflation is too high, the Fed can increase the target federal funds rate to rein in borrowing.
Fluctuations in the federal funds rate don’t directly affect mortgage rates, but they influence other factors that do, like the cost of conducting business for banks.
Benefits of Buying a Home When Interest Rates Are High
Higher interest rates could be a blessing in disguise for prepared homebuyers. Here are some advantages of buying when interest rates are high.
Lower home prices
When interest rates are high, getting a mortgage becomes more expensive.
“The rise in interest rates has encouraged many buyers, particularly those with an existing property at a better rate, to pause their search,” says Rachel Bennett, a real estate agent at Orchard based in Austin, Texas. “As a result, there is far less competition in the market than there was when interest rates were considerably lower.”
When supply exceeds demand, the market favors buyers. Bennett says that the shift toward a buyer’s market gives homebuyers more ammunition to negotiate with sellers, who may need to lower their asking price.
While home prices historically have appreciated over time, periods of higher interest rates can mean a price drop.
Less risk for buyers
To protect the buyer, certain contingencies can be added to the purchase agreement. These contingencies must be met for the sale to go through.
For example, a common one is the home inspection contingency. If the home inspection reveals major issues with the home, the buyer can negotiate with the seller about completing the repairs before closing or covering the costs, or back out of the deal without consequences.
Sellers usually prefer offers that come with fewer or no contingencies. In a seller’s market, buyers may waive contingencies to compete with other offers. However, this puts buyers at risk of inheriting expensive issues with the home or losing earnest money if they end up backing out.
The good news is that when interest rates are high and there’s less competition for homes, buyers have more leverage to include the contingencies they need to protect themselves financially and feel comfortable with their offer.
Disadvantages of Buying a Home When Interest Rates Are High
Buying a home when interest rates are high comes with some obvious downsides.
Higher monthly payments
Your monthly mortgage payment is mostly determined by the loan principial — which is the amount you borrowed — and your interest rate. A higher rate means paying more for your mortgage each month and overall, which affects how much you have left over for other expenses and goals.
You can’t borrow as much money
To approve your home loan, the lender needs to verify that you have enough income and assets to keep up with your payments. If your interest rate is higher, the loan amount you can qualify for is smaller, and you might not be able to afford properties in the price range you’re targeting.
“Even the smallest shift in rates can change one’s buying power,” Bennett says.
You could get priced out of the market
Many people may feel their homebuying dreams slip out of reach when it becomes more expensive to borrow. Though homeownership could have been attainable with lower mortgage rates, some simply can’t afford the higher monthly payments when interest rates rise.
Alternative Financing Options When Interest Rates Are High
In response to rate hikes, some lenders are marketing alternative financing options to help buyers lower their interest rate. However, these options could come with significant trade-offs, so it’s important to understand the risks and whether you’d be losing money in the long run.
Adjustable-rate mortgage
Compared with fixed-rate mortgages, ARMs have a lower interest rate at first. After a fixed introductory period — which can last five, seven, or even 10 years — the rate will adjust from time to time and can change depending on market conditions.
Getting an ARM means you’ll start off with a comparably lower mortgage rate, and the fixed period gives you time to refinance your mortgage to better terms, if qualified. But you could face a higher mortgage rate once initial period ends, so you should be prepared to keep up with more-expensive payments.
Temporary buydown
A temporary buydown occurs when you pay an upfront cost at closing to get a lower mortgage rate for the first year or two of your loan term.
Although you’ll earn a reduced rate initially, it could cost you more in the long term. Loans with a temporary buydown can end up being more expensive than fixed-rate mortgages without a buydown, so you’ll want to crunch the numbers to check if you’re actually saving money.
Loan assumption
A loan assumption is when you take over the remaining balance on a seller’s mortgage with their original terms, potentially giving you an interest rate below current market rates.
With a loan assumption, you’ll cover the difference between the sales price and the assumed loan’s outstanding balance. That means this option may be less feasible for people who don’t have larger cash reserves, especially because it can be difficult to find a lender willing to offer a second mortgage to make up the difference.
You’ll want to ask your lender if loan assumption is an option and talk with the seller about the terms of their outstanding mortgage.
The Risks of Trying To Time the Mortgage Market
With interest rates reaching historic lows during the COVID-19 pandemic, you may feel tempted to hold off on buying a home until rates drop again. However, there’s no guarantee that this will happen on your timeline. After all, interest rates have been much higher. In 1981, for example, rates hit 16.63%.
“The 3% rates during the pandemic were quite an anomaly,” Bennett says. “With the high cost of rent, no guarantee of a locked-in rate, and the fact that rent is essentially 100% interest, I would encourage people to buy if they can and start building equity rather than covering someone else’s loan costs.”
Can I buy and refinance when rates are lower?
Some buyers assume they can buy a home when interest rates are high and refinance their mortgage later. However, there’s no way to predict the housing market and no guarantee that rates will eventually come down. That’s why it’s important to make sure you can afford to keep up with your current mortgage payments.
Should You Buy When Interest Rates Are High?
Deciding whether you should buy when interest rates are high depends on your financial situation. If you are prepared and can afford the monthly payments, then periods of higher interest rates offer less competition and more leverage for homebuyers.
Also, buying when interest rates are high doesn’t necessarily mean you’ll be stuck with that rate forever.
“I always advise buyers to date the rate and marry the house,” Bennett says. “When you find the perfect property for your needs, go for it. You can always refinance later if rates go down.”
FAQ: Buying a Home When Mortgage Rates Are High
Here are the answers to frequently asked questions about buying a home when interest rates are high.
Over the last several years, interest rates have gone from reaching historic lows to hitting the highest rates in almost 20 years, which means it’s more expensive to buy a home now.
But while higher interest rates mean higher costs — at least in the short term — you’ll be able to start building equity if you purchase sooner rather than later.
“In the long term, home values go up,” Bennett says. “The best time to buy a home was 20 years ago. The second-best time is now.”
While many financial experts may offer forecasts, the truth is that there’s no certainty regarding when — or how much — interest rates will decrease.
“It is impossible to know when interest rates will decrease, especially given that the current rates are more in line with historical rates,” Bennett says.
The Bottom Line on Buying When Interest Rates Are High
Higher interest rates make borrowing money more expensive. If you’re looking to get a mortgage to buy a home, you can expect higher monthly payments and more-expensive loan costs overall. However, the ability to start building equity sooner may be worth it in the long run — especially since qualified borrowers can refinance if interest rates drop in the future.
