Ideally, the road to buying a home starts with getting the best mortgage rate. If we had it our way, we’d be able to spend as much time as we like to search for the perfect home while also knowing that mortgage rates won’t increase in the meantime. But what happens if mortgage rates change?
If rates decrease, you’re in luck. On the downside, if mortgage rates increase and you just barely qualify for a mortgage, it might make it a little more difficult to get the home you plan on buying.
One of the key benefits of getting a mortgage pre-approval is that you’ll lock in today’s best rates. We’ll take a look at what happens if mortgage rates change in two scenarios and what happens in each case.
Scenario #1: Buying a home without a pre-approval
Let’s assume you’re going to buy a $625,000 home with a down payment of $125,000, you get a five-year fixed mortgage rate of 2.33%, and choose an amortization period of 25 years. Your monthly payments will be $2,198. But if rates rise by 0.20 percentage points to 2.53%, your monthly payment increases to $2,247. Each year, the additional interest you’ll be paying adds up to about $588. Over five years, that adds up to $2,940. At this point, another option you might have is to try finding a different mortgage lender who’ll approve you for a lower rate.
Although it’s difficult to determine when rates will change, some economists predict an increase in 2017. Since getting a mortgage pre-approval is a free and easy process, you don’t have anything to lose when locking in your rate.
Scenario #2: Getting pre-approved for a variable-rate mortgage
If you do get pre-approved for a variable-rate mortgage, keep in mind that the rate isn’t guaranteed if the prime rate increases. What’s guaranteed is your discount to the prime rate if the lender reduces the discount for all borrowers.
We’ll look at one example of how much more you’ll have to pay if the prime rate changes while you’re in the middle of buying a home. Today’s prime rate is 2.70%. If the discount is prime minus 0.65%, your rate will be 2.05% (2.70%-0.65%). Taking the same mortgage from the previous example but at a 2.05% rate, your monthly mortgage payments will be $2,129.
But if the prime rate rises to 3%, the discount falls to prime minus 0.35%, and you were pre-approved for a mortgage, you still get the discount of prime minus 0.65%. In that case, your rate is 2.35% (3%-0.65%) and your monthly mortgage payment would rise to $2,203.
Unfortunately, if the prime rate rises, you can’t do anything about it with a variable-rate mortgage. However, since you did get pre-approved, you do save money because the discount dropped to prime minus 0.35%. If you didn’t get pre-approved, your mortgage rate would have been 2.65% (3%-0.35%) and your monthly mortgage payment would have been $2,277. Over five years, that adds up to $4,440 in savings.
The bottom line
If rates rise while shopping for a home, getting pre-approved for a fixed-rate mortgage will protect you from the increase. While getting a pre-approval for a variable-rate mortgage won’t protect you from rising rates, it will allow you to keep the discount to prime in the event the lender reduces the discount.
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