Some homebuyers are facing ‘payment shock.’ Ways to save on a mortgage

Even with signs that the housing market is cooling, homebuyers are still feeling the sting of elevated prices and higher interest rates.

The average rate on a 30-year fixed-rate mortgage is 6.7% as of Friday, up from 3.3% at the start of 2022, according to Mortgage News Daily. Alongside that, home prices — the median is $435,000 — are up 13.1% on average from a year ago, according to Realtor.com.

“I think the major problem is payment shock,” said Stephen Rinaldi, president and founder of Rinaldi Group, a mortgage broker based near Philadelphia. “When I sit down with clients and the rate is in the 6s, their payment is outrageous sometimes.”

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The difference that interest rates make can be significant. For illustration: On a $300,000 mortgage at 6.5% over 30 years, monthly payments for principal and interest only would be $1,896. That same loan at 3% would result in a payment of $1,264 (a savings of $632 monthly). Other charges such as property taxes or mortgage insurance would be on top of those monthly amounts.

Yet there are ways to reduce the cost of buying a house. While there’s no one-size-fits-all approach, you can evaluate various options available to you and consider whether any of them make sense for your situation.

Here are some options.

An adjustable rate mortgage may be worth considering. With an ARM, as it’s called, the appeal is its lower initial rate compared with a traditional fixed rate mortgage.

That rate is fixed for a set amount of time — say, seven years — and then it adjusts up, down or remains the same, depending on where interest rates are at the time.

While there’s a limit to how much the rate can change, experts recommend making sure you’d be able to afford the maximum rate if faced with it down the road. As illustrated above, a few percentage points can make a big difference in the monthly payment.

Keep in mind, though, that at any point before the rate adjusts, you may be able to refinance your mortgage, said Rinaldi.

Or, if you anticipate moving before the initial rate period expires, an ARM may make sense. However, because life happens and it’s impossible to predict future economic conditions, it’s wise to consider the possibility that you won’t be able to move or sell.

Additionally, if the ARM rate isn’t much lower than a fixed rate, the savings may not be worth the uncertainty. Rinaldi said that while some lenders aren’t offering much in the way of a discounted rate, he’s finding some that are about one percentage point or more lower.

While the typical mortgage is for 30 years, a shorter loan with a more favorable rate may be appealing. The average rate for a 15-year loan is 6% as of Friday, according to Mortgage News Daily. Additionally, you save a boatload in interest over the life of the loan and you build equity in the house faster.

For illustration: A 30-year, $300,000 mortgage with a fixed 6.5% rate would mean paying $382,786 in interest over the life of the loan. In comparison, a 15-year mortgage, even at the same rate, would translate into paying $170,438 in interest during the loan.

“It’s not just the rate difference, but the equity buildup, too,” said certified financial planner David Demming, president of Demming Financial Services in Aurora, Ohio.

At the same time, he said, if the higher payment squeezes your budget too much, it may not be the best route.

If you’re a first-time homebuyer with limited means, you may be able to qualify for one of the federal programs available that help you buy a house with a lower down payment and reduced closing costs. Additionally, state and local governments (city or county) often offer grants or no-interest loans to help buyers cover their downpayment and closing costs.

Sometimes, a potential homebuyer might be unable to qualify immediately for a mortgage due to credit issues or short work histories. Or, they might need more time to save for a down payment but want to get in a house and stay put.

In those cases, it may make sense to consider a lease- or rent-to-own contract. One common aspect of these arrangements is for a portion of the monthly rent to go into an escrow account until the date of purchase a couple or few years down the road, at which point the your escrowed amount goes toward closing costs or a down payment. But if you walk away or otherwise can’t meet their contractual obligation, the money is forfeited.

If you consider going this route, It’s important to do your due diligence and make sure you understand the terms of the contract — including the type of mortgage the property is eligible for and how the purchase price will be set, Demming said.

You may be able to negotiate closing costs, such as the fees you pay for various aspects of the home-buying process or by using a lower-cost title company. Or, the seller may be willing to pay some of your costs, depending on competing offers presented.

You also may be able to buy extra “points” — one point is worth 1% of the loan amount — to get a lower interest rate.

However, Rinaldi cautions that because it can take years to break even when you go this route, it may not be worth it.

“You don’t want to pay extra origination charges because if you refinance, that’s lost money,” Rinaldi said.