Mortgage rates are expected to decline next year, but that doesn't mean prospective home buyers should necessarily hold off on buying because of the prospect of lower financing costs.
The interest rate on a 30-year fixed mortgage will drop to an average of 4.5% in 2023, according to a recent housing forecast published by Fannie Mae, a government-sponsored lender.
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This dynamic would offer some relief to would-be homebuyers who have seen mortgage interest rates soar this year.
The Federal Reserve (Fed) began raising its benchmark interest rate in March to rein in stubbornly high inflation, which has translated into rising borrowing costs for consumers, who may feel a whiplash from 2020, when rates bottomed near historically low levels.
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Median rates are expected to be 4.7% and 4.4% in the first and fourth quarters of 2023, respectively, up from 5.2% in the second quarter of this year, according to Fannie Mae.
Still, consumers should "take forecasts with a grain of salt," according to Keith Gumbinger, vice president of HSH, a market research firm.
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“If you participate in the market, interest rates are important, but they may not be the most important component,” Gumbinger explained.
How interest rates affect your portfolio
Rates on a 30-year fixed mortgage — whose interest rate doesn't change over the term of the loan — have risen more than two percentage points since the beginning of 2022.
Rates averaged 5.55% the week of June 23, according to data from Freddie Mac, another government-sponsored entity.
This figure is significantly higher than the 3.22% in the first week of January, although it represents a slight decrease compared to the maximum of 5.81% reached in June.
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Even a seemingly small jump in mortgage costs can have a big impact on consumers, through higher monthly payments, more interest for life, and a smaller total loan.
Here's an example, based on MSM data: With a fixed interest rate of 3.5%, a homebuyer with a $300,000 mortgage would pay about $1,347 a month and $185,000 in total interest over 30 years.
At a 5.5% rate, the homeowner would pay $1,703 a month and more than $313,000 in interest for the same loan amount.
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Here's another example, assuming a buyer has an annual income of $80,000 before taxes and makes a down payment of $30,000.
This buyer would be entitled to a $295,000 mortgage if rates were 3.5%, about $50,000 more than the same buyer with a 5.5% rate, according to HSH data.
That differential can put a certain home out of your reach.
What Prospective Buyers Should Consider
Many consumers have opted for a variable rate mortgage over a fixed one as borrowing costs have skyrocketed.
Variable-rate loans accounted for more than 12% of mortgage applications in both June and July of this year, the largest proportion since 2007 and double the percentage in January of this year, according to Zillow data.
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These loans are riskier than fixed-rate mortgages.
In general, consumers pay a fixed rate for five or seven years, after which it is readjusted;
then, consumers may have to pay higher monthly fees depending on market conditions.
Kevin Mahoney, a Washington, DC-based certified financial planner, favors fixed-rate loans for the security they offer consumers.
Homebuyers with a fixed mortgage can refinance and lower their monthly payments if interest rates drop in the future.
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More generally, consumers should avoid using mortgage estimates like Fannie Mae's to guide their buying decisions, he added.
Personal circumstances and desires should be the primary driver of financial decisions;
furthermore, these predictions can be wildly inaccurate, she said.
"In some cases, you can chase better numbers for years if things don't go your way," said Mahoney, founder and CEO of millennial-focused financial planning firm Illumint.
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However, prospective buyers may risk waiting if they don't have a rigid timetable for the purchase and have a cushion in their budgets in case mortgage rates don't move as expected, Mahoney added.
Consumers who find a home they like -- and can afford to buy it -- are probably better served by seizing the opportunity now rather than delaying it, Gumbinger said.
Even if borrowing costs improve next year, overall affordability will remain a challenge if home prices remain high, for example, he added.
