A 3% mortgage sounds great — until it makes you feel trapped when you want to move.
This is the dilemma many Americans who bought homes during the pandemic face. They snagged super-low rates and affordable monthly payments. But as mortgage rates have soared over the last three years, survey after survey has shown that those homeowners feel locked in, reluctant to give up their cheap mortgages for ones twice as expensive.
For homeowners who don’t need to move, staying put is the easy choice. A home renovation costs less than moving and can make an existing home more comfortable. But what about people who get new jobs in another state or require more room for a growing family?
Jonathan Greene, founder and broker of record at the real estate brokerage Streamline, regularly finds himself talking to clients about when sacrificing an inexpensive mortgage makes sense. Greene says he has found that, for many people, worrying about losing their low interest rate leads to inaction and delays a necessary decision.
“The rate is what it is,” Greene says. “Get the blockade of yourself out and agree that this is the best time to go.”
Even if you choose to let go of a low mortgage rate, you should still explore ways of minimizing the impact that moving to a much higher rate can have on your budget. Here are a few options to consider.
Take advantage of your home equity
Longtime homeowners and folks who bought property during the pandemic may not realize they have a huge asset in their home. Because home prices increased so dramatically during the buying frenzy of 2020-2021 — by as much as 80% in some cities, according to the National Association of Home Builders — many people have large levels of home equity they can leverage into a new home purchase.
“Look at how much appreciation you’ve earned on your current house,” Greene says. “If you’re up $250,000, that means you did a great job with that asset.”
You can use that equity in several ways to lessen the impact of a mortgage rate change on your wallet. For example, the equity can help you make a larger down payment on your next home, enabling you to qualify for a better interest rate and keep your monthly payments affordable.
Since homes tend to appreciate over time, you may find that your next home will also increase in value. When you do sell that future property, Greene says, “you’re not going to be upset that you made the move.”
Buy down your interest rate
Another way to use your gained equity to lower the borrowing costs of a new home is to negotiate a rate buydown, which is a fee you pay at closing to reduce your interest rate and monthly payment. A rate buydown can be temporary or permanent, and it’s paid to the lender.
A temporary rate buydown can be a 1-, 2– or up to 3-percentage-point reduction spread over one to three years. Once the buydown period ends, the rate returns to the original interest rate you qualified for.
A permanent rate buydown, also known as buying points, is a reduction that lasts for the life of the loan. Typically, each point costs 1% of the loan amount and reduces your rate by 0.25 percentage points. For example, say your lender is offering a 6.5% rate on a $400,000 loan. Buying one point costs $4,000 and reduces your rate to 6.25%. You can also try to negotiate a rate buydown as a seller concession when negotiating the home purchase.
Each lender has its own policies on points, so make sure you understand your options and the full costs before adopting this strategy. Also, plan to stay in the home long enough to reach your break-even point (or recover the cost of buying the points).
Look for an assumable loan
An assumable loan lets you take over an existing loan, including its interest rate, terms and monthly payments. Typically, these are government-backed loans, like from the Federal Housing Administration (FHA), Department of Veterans Affairs (VA) and Department of Agriculture (DA).
Rose Krieger, senior home loan specialist at Churchill Mortgage, says she has seen increased interest in this type of loan from buyers looking for lower rates and more affordable payments.
Here’s how it works: A seller lists their home for $400,000 with an assumable loan at 3.5%. Their loan balance is $350,000, with 23 years left. If the buyer meets all lender and loan requirements and is approved, they take over the existing $350,000 loan at 3.5% for the remaining 23 years — at which point the loan will be paid off.
The caveat is that the buyer must pay the difference between the loan amount and the sales price, which in this example is $50,000. (That’s an amount that could be covered by the equity gained from the sale of the new owner’s previous home.)
This route has drawbacks. Krieger points out that a lot has to fall into place for an assumable loan to work. These loans also typically take longer to process than a typical mortgage — potentially up to six months compared to the 30 to 45 days of a non-assumable loan. Plus, the cash amount due to cover the difference between the assumable loan and the sale price can be substantial.
Recast your new mortgage
A mortgage recast is a large lump-sum payment toward the principal on your outstanding loan balance. Not all lenders allow recasts, so check with yours to see if this option is available.
How recasting may affect your loan depends on your lender. The monthly payment may decrease to reflect the new principal, while your interest rate and loan term are unchanged. Conversely, your loan may amortize faster, reducing the total interest you’ll pay over time but leaving your monthly payment unchanged.
Sarah DeFlorio, vice president of mortgage banking at William Raveis Mortgage, says a rate modification is another option. Instead of a full refinance, which would require you to pay closing costs, you pay your lender a small fee to reduce your rate on the remaining loan balance permanently.
Ultimately, whether you should give up a low mortgage rate depends on your needs and what makes the most long-term financial sense. But if you find a nice place that fits your needs, you might not want to wait.
“You may regret losing the home more than having a slightly higher mortgage payment,” DeFlorio says.
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