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 want to buy a $625,000 home with a 20% down payment of $125,000. If you get a five-year fixed mortgage rate of 2.84% and choose an amortization period of 25 years, your monthly payments will be $2,325 (all of our calculations are determined by using our mortgage payment calculator). But if you hold off on buying a home and rates rise to 3.34% in the meantime, your monthly payment will increase to $2,454.
Although it’s difficult to determine if mortgage rates will change, some predict rates will continue to move higher. Since getting a mortgage pre-approval is a free and easy process, you don’t have anything to lose when locking in your rate. If rates decline, you won’t be stuck with the pre-approved rate.
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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 3.2%. If the discount is prime minus 0.45%, your rate will be 2.75% (3.2%-0.45%). Using the same purchase and down payment example above but at a 2.75% rate, your monthly mortgage payment will be $2,303.
But if the prime rate rises to 3.7%, the discount falls to prime minus 0.15%, and you were pre-approved for a mortgage, you still get the discount of prime minus 0.45%. In that case, your rate is 3.25% (3.7%-0.45%) and your monthly mortgage payment will rise to $2,431.
Unfortunately, if the prime rate rises, you can’t do anything about it with a variable-rate mortgage. However, since you were pre-approved, you do save money because the discount dropped to prime minus 0.15%. If you didn’t get pre-approved, your mortgage rate will be 3.55% (3.7%-0.15%) and your monthly mortgage payment will be $2,510.
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. If you’re wondering how to get a mortgage pre-approval, a mortgage broker can help.
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