Terence Loose | Yahoo! Homes –
Mon, Jul 1, 2013 7:16 PM EDT
When it comes to mortgage interest rates, here's what we know: Although interest rates have risen in the past few weeks, they are still pretty low compared with just a few years ago.
In fact, on June 27, 2013, the average interest rate on a 30-year, fixed-rate mortgage was 4.46 percent, according to Freddie Mac. If we take a look at what interest rates were five years ago in June 2008, however, they were at a whopping 6.32 percent, according
to Freddie Mac. But although rates now are relatively low compared to what they were five years ago, they're still on the rise - and there's no telling how high they'll go.
So if you're still not convinced that now is the best time to refinance your mortgage, read on to find out what could happen if you wait…
debt-to-income ratio is the amount of your total monthly debt as a percentage of your total gross monthly income. Your debt includes things like credit card bills, car loan payments, and the payment on the mortgage you want to get. This number generally
can't be higher than 40 percent, says
Jim Duffy, a
mortgage banker with Cole Taylor Mortgage in Atlanta, Georgia.
But, the higher your mortgage interest rate, the higher your monthly payment - and the more difficult it might be to qualify for the lowest rates that are available, says Gross.
"So, if the interest rate [on your mortgage] goes up, that means the payment goes up and if the payment goes up that could potentially take you out of the qualification range," says Gross.
To see how this works, let's see what happens to the debt-to-income ratio for a couple making a gross monthly income of $5,000 who wants to refinance a 30-year, $300,000 fixed-rate mortgage at today's 4.46 percent rate, and then at a rate of 6.32 percent.
For the sake of the example, we'll assume the couple's monthly expenses, other than the
mortgage payment, come out to $500. Remember, this includes only things like credit card payments, car loans, etc., not food, utilities, and the like. For this couple, the $1,512 mortgage
payment on a $300,000 mortgage at 4.46 percent puts their debt-to-income ratio right at 40 percent. So they could still qualify.
But at an interest rate of 6.32 percent, their payment would jump to $1,860.83. This would raise their monthly debt to $2,360.83, and their debt-to-income ratio to 47 percent. They are now a higher risk than most lenders would accept, according to Duffy's
Basically, there are two ways to get the lowest
interest rates available. The first is to be a stellar applicant in all ways - sterling credit, very low debt-to-income ratio (see above for definition), a fat savings account for rainy
days, etc. The second way is to "buy" your rate down through paying "points."
Points are a one-time charge paid to the lender to reduce the interest rate you pay over the life of your loan, according to "A Consumer Guide to Mortgage Settlement Costs" by the
Federal Reserve Board (FRB).
So, back to the question of whether a rising interest rate could increase costs. The answer is yes, and here's why: If a borrower wants to take out a $300,000 mortgage today, he can get a 4.46 percent interest rate on a 30-year fixed-rate mortgage with no
discount points. If the rates go up to 6.32 percent and that borrower wants a lower interest rate, they would now have to pay a discount point to drop it down to maybe 5 percent or two points to get it to 4 percent.
In terms of how much it will cost you, the FRB notes that each percentage point you want to shave off of your interest rate will cost one percent of the loan amount.
When it comes to financing homes, small increases in interest can result in big changes to the total amount of interest paid over the life of a 30-year, fixed-rate mortgage. Why? "Because, the price
of the home plus the price of financing the home - the interest rate - is its true cost," says Duffy.
He adds that it's only natural that most people pay more attention to the monthly payment, because that's how we all budget our incomes. But he advises people to look at the
lifetime interest cost too. And when they do, one thing sticks out: seemingly small changes in the interest rate can have major affects on the lifetime cost of your home.
To see what that means from the perspective of an interest rate of 6.32 percent, let's compare today's 4.46 percent interest rate to the 6.32 percent rate from 2008 with three different 30-year, fixed-rate mortgage amounts.
The numbers speak for themselves; if you waited to refinance and mortgage rates went back up to 6.32 percent, you'll face paying thousands more over the life of your loan than if you refinanced now at 4.46 percent. Depending
on where you live, you could buy another home for that amount!