Ask Eli: Ideas for reducing your interest rate

This regularly scheduled sponsored Q&A column is written by Eli Tucker, Arlington-based Realtor and Arlington resident. Please submit your questions to him via email for response in future columns. Video summaries of some articles can be found on YouTube on the Ask Eli, Live With Jean playlist. Enjoy!

Question: Are there any good ways to lower my interest rate?

Answer: I probably don’t need to spend time educating you on how high interest rates have gotten over the last 6 months (they’ve more than doubled in most cases), but we’re now seeing rates in the upper 5% to mid-6% range on most loans. Unfortunately, the current economic environment makes it more likely that rates continue to climb and most lenders I speak to tell me they’re expecting rates in the 7-8% range later this year.

While there isn’t much you can do to change your rate in a significant way, just like you can’t do much about the price of gas, there are some strategies you can use to help. I spoke with Jake Ryon ([email protected]) of First Home Mortgage about things he recommends to help bring down your rate.

Consider ARMs (Adjustable Rate Mortgage)

ARMs got a terrible reputation during the housing crisis because many borrowers didn’t understand the terms of their loan. Some of these options allowed for negative amortization so borrowers opting for the lowest rate ended up owing more on their loan than when they started. Many of these options, and the sometimes predatory approach to lending, have been outlawed so the ARMs you see today are a distant relative of the ARMs of the housing crisis.

What is an ARM?

Simply put, an ARM is a loan with an interest rate that is locked for a set period of time (usually 5, 7, or 10 years) that can adjust (up or down) after that set period, based on market rates. The rate will continue to adjust up or down based on market rates with limits on how much a rate can change each year and throughout the life of the loan.

Why should you consider it?

In the current interest rate environment, you’ll usually see lower interest rates on an ARM than on a standard 30-year fixed mortgage. The difference can be roughly .5-1%, which is a significant savings on interest payments.

What about the risk?

The risk of an ARM is that if rates remain high or end up higher at the end of your lock period, your rate will adjust upwards. The gamble you’re taking (based on historical rate trends, it’s a good bet) is that rates will drop enough to justify refinancing into a lower 30yr fixed rate before your ARM lock period expires.

Over the last few years when rates were so low, ARMs didn’t make sense because they were so close to a 30yr fixed rate (sometimes higher), so you haven’t heard people talk much about their benefit until more recently when the spread between the two has increased.

Buy Origination Points

In most cases, you can buy “points” on your loan to decrease the interest rate. One point equals 1% of your loan amount and for a while, you were seeing a reduction of around .25% in rate for a point. In the current interest rate environment, buying a point may lower your rate by as much as .5-.75%.

Discuss this with your lender up-front so you’ll know if you should budget additional cash to lower your interest rate. Your lender can also calculate the break-even point on this investment, which is essentially calculating how long you need to be in the loan (own the property) for the money saved in interest payments to exceed the amount you paid for the point.

Increase Down Payment

Sorry if this seems obvious, but for years when rates were so low, many buyers were choosing to put less money down, even if they had more funds available, because the cost of borrowing was so low, they felt they could use the extra cash more effectively in other savings/investment vehicles.

That financial strategy is no longer as attractive and using as much down payment as you can muster is gaining favor in financial advisory circles. In general, you achieve the best interest rates with a 20-25% down payment, with little improvement beyond that. However, putting more money down can still make a lot of financial sense even if it doesn’t lower your rate because the interest payments on borrowed money are so high now.

There are still plenty of loan options for buyers with less (3-5%) to put down, but those rates have shot up and carry higher mortgage insurance premiums.

It’s now even more important to get pre-approved and open discussions with a trusted lender at the beginning of your home search (here’s a link to an article I wrote about picking a good lender). If you have any questions about finding a lender or want recommendations, don’t hesitate to email me.

If you’d like to discuss buying, selling, investing, or renting, don’t hesitate to reach out to me at [email protected].

If you’d like a question answered in my weekly column or to discuss buying, selling, renting, or investing, please send an email to [email protected]. To read any of my older posts, visit the blog section of my website at EliResidential.com. Call me directly at (703) 539-2529.

Video summaries of some articles can be found on YouTube on the Ask Eli, Live With Jean playlist.

Eli Tucker is a licensed Realtor in Virginia, Washington DC, and Maryland with RLAH Real Estate, 4040 N Fairfax Dr #10C Arlington VA 22203. (703) 390-9460