As always, our goal is to inform you on mortgage rates, the factors influencing them, and provide tips for navigating the loan process.
We recently analyzed the current market rates, including what has influenced rates and trends from the past 10 years. We summarized that interest rates had risen to levels last seen in the early 2000’s, with no apparent end to their historical rapid rise. We may have some good news though!
We’ll be covering the following topics:
- Current Mortgage Rate Trends and What to Expect
- What a Buy-Down is and When It’s Best Utilized
- Everything You Need to Know about PMI
Mortgage Rate Trends
We may have some good news based on current trends we are seeing in mortgage rates!
The US Bureau of Labor Statistics releases several types of inflation data monthly. The most pertinent is CPI (Consumer Price Index), designed to gauge changes in consumer prices on a month/month, year/year basis. We got that data November 10th, and it showed a surprising drop in prices over expectations. “Core CPI”, the data most pertinent to bond markets, was projected to rise .5%, but only rose .3%. How did bond markets react? Rates dropped dramatically, nearly .25% on Thursday! Here’s a chart illustrating the movement, courtesy MBSLive.net:
From late October to November 7th, treasury yields touched over 4%, their highest in 15 years. On November 10th, they reacted to November’s CPI by dropping from 4.1% to 3.8% in a single day!
Does this mean interest rates have topped out, and will continue to drop now?
While that would be great, we cannot presume they will. What we do know is that we have (at least) a temporary pause in rates’ upward march. Hopefully rates have hit their ceiling, meaning we won’t exceed October’s levels. Future movement will depend on economic data, including CPI, Non-Farms Payroll (aka NFP or Jobs Report) and the Federal Reserve’s outlook.
Does strong economic data help or hurt rates?
While it might seem counterintuitive, strong data is seen as an inflation trigger, which hurts rates. The Federal Reserve has been sharply raising their overnight rate to lower consumer demand, with a goal of lower inflation. Last week’s CPI data shows the Federal Reserve’s aggressive interest rate hikes may indeed be accomplishing their goal.
Does this mean the Federal Reserve will change their policy and stop raising the overnight rate?
Hardly, but it’s still good news. Picture the economy as a huge ocean liner (ideally not the Titanic!) Turning/slowing/speeding up such a ship is a gradual process, rather than an instant one. As the Fed sees their rate hikes slowing inflation, they will adjust “their steering” (rate hikes and economic outlook) hoping they can point the economy in the desired direction. Remember, the Fed’s long-term goal is 2% annual inflation.
Mortgage Rate Buy-Downs
I’ve seen some lenders advertising ‘buy-downs’. What are those, and should I pursue one?
Buy-downs are a tool (typically seen during periods of high interest rates) for homebuyers to achieve more affordable initial payments, with the hope of either refinancing if rates drop, or increasing their income to offset the higher payments when the buy-down ends. Borrowers get temporarily reduced rates for their loans’ first few years. The most common are 2/1 or 3/2/1 buy-downs. A 2/1 buy-down means the first year’s rate is 2% below the loan’s long-term rate, second year is 1% below. 3/2/1 buy-downs mean first year is 3% below actual rate, second year is 2% below, third year is 1% below. The rate returns to “normal” when the buy-down period ends.
How much would a buy-down help me?
On a $200,000 mortgage with a 6% interest rate, the first year’s principal and interest payment (not including taxes or insurance) with a 3/2/1 buydown would be $843, as opposed to the regular payment of $1199. On a $500,000 loan, those payment would start at $2,108 before rising to $2,997 when the buy-down ends.
Buy-downs sound great, I can save hundreds per month, why wouldn’t everyone utilize an interest rate buy-down? What’s the catch?
While the initial payments are lower on loans with buy-downs, that interest must still be accounted for. Those costs (the reduced interest paid by borrower during the buy-down period) are paid by either the home’s seller or the lender involved. Note that borrowers don’t pay buy-down costs, since they are essentially prepaid interest. That’s why buy-downs are only an option on purchase loans. It wouldn’t do much good to prepay interest for a buy-down on a refinance, since the borrower would still be paying the same total interest over the life of the loan.
How can I get a buy-down on the home I want to purchase?
Buy-downs are pricing concessions, similar to seller paid closing costs. Your offer on the home would need to clearly state “seller to pay buydown costs for a 3/2/1 (or 2/1) buy-down.” The seller would pay the buy-down’s cost at closing, just as with the more common seller paid closing costs. That may well mean the sales price will be higher than if no buy-down is utilized, depending on the seller’s motivation and area market demand. It’s also important to remember that there are limits (depending on down payment and loan type) on seller paid costs. Lenders can also fund buy-downs, typically by accepting lower profit margins (or slightly higher mortgage rates on loans with buy-downs).
I don’t have a lot of cash on hand, would seller paid closing costs or a buy-down be best for me?
Since buy-downs don’t impact the amount buyers are responsible for at closing, seller paid closing costs (as opposed to a seller paid buy-down) would likely be your best strategy. You certainly wouldn’t want to use all your available funds for closing, since there are always costs (both anticipated and not) for furnishing and maintaining your new home. It’s no fun to close on a new house, then have to borrow money to furnish it!
Private Mortgage Insurance (PMI)
My loan officer says I need PMI since I don’t have a 20% down payment. How do I get it, and how much is it?
Thanks for asking. PMI stands for private mortgage insurance and is required on all Fannie Mae/Freddie Mac loans with less than 20% equity (whether refinance or purchase). The cost is based on multiple factors: loan purpose (purchases are deemed lower risk than cash-out refinances); property type (a multi-unit building or condo has higher risk than a single family home); equity (loans with 15% equity have lower risk than those with 5%); credit scores (higher equals less risk); debt ratios (lower is less risk); the number of borrowers on the loan (more is less risk); location; how long the loan is for; whether borrowers are self-employed (higher risk); and loan size. If this sounds complicated, you clearly get the picture. Fortunately for lenders and borrowers, PMI companies have greatly improved their risk assessments, leading to lower premiums on loans their algorithms like. PMI companies have pricing portals so lenders can calculate PMI costs (provided the above information is all accurate). Your loan officer should be able to give you a virtually exact projection on what your PMI costs will be.
Will I have to pay PMI forever?
There are strict federal requirements on PMI, especially on removing it. In general, PMI charges can be dropped when the loan balance is paid down to 80% of the appraised value. Since equity builds far faster on 15- or 20-year mortgages, compared with 30-year loans, PMI falls off faster on shorter loans. If you make extra principal payments to reduce your balance, you will also be able to drop PMI sooner. Regarding “dropping my PMI at 20% equity”, that’s when borrowers are eligible to drop their coverage, but they must contact their loan servicer to do so. We recommend setting a calendar reminder for this as typically you can request the PMI be dropped a year before it would normally drop off. Never fear, if you forget, your PMI will drop off automatically when you reach 22% equity. Note, we’re assuming your mortgage has been paid as agreed in this discussion.
Are there loans that don’t require 20% down and don’t have monthly PMI costs?
Yes, kind of. “Borrower paid PMI” involves a lump sum premium (rather than a monthly cost) added to your loan at closing, and “lender paid PMI” is, as you might have guessed, paid by your lender as a onetime charge. Lenders adjust their rates higher on loans with lender paid PMI, so it’s not free money. There are downsides to both these: If you pay a hefty upfront PMI premium, then refinance or move within a short period, you won’t get that premium refunded. If you accept a higher rate in exchange for lender paid PMI, your payment will be impacted for the entire life of your loan, regardless of equity. Government loans (FHA/VA/USDA) have different requirements and terminology on mortgage insurance. FHA charges “mortgage insurance premiums” that include both an initial and monthly charges (AND, in most cases DO last for the life of the loan!) VA loans have “funding fees” (unless a veteran has a VA disability rating) that’s added to the loan balance at closing, and USDA loans have both initial and monthly “guarantee fee” costs.
My buddy bought a house with 10% down, then refinanced two years later and wasn’t required to have PMI on his new loan. How did that happen?
When a new loan is taken out, lenders base equity calculations on the new/current value, rather than the initial purchase price. If your property has risen in value, you may have adequate equity to drop the PMI. Another alternative is to make improvements to the property, then ask your servicer to have an appraiser determine the new value. Note, we’re talking major improvements, like a kitchen remodel or finishing a basement. “I planted some new bushes and painted the den” might have improved your home’s aesthetics but won’t significantly improve the value.
Contact Us with Home Loan Questions
Homesite Mortgage offers conventional, USDA, FHA and VA loans to the states of Illinois, Michigan, Missouri and Florida. Our loan experts can help you navigate the process and answer any questions you have.