Mortgage Rate Hacks: HBAs, 5/1 ARMs, and more

Everyone—from CNBC to The Wall Street Journal—is talking about declining home sales and the return of “buyer power.” 

It is true that buyers are getting pickier and that expectations are rising. We’re no longer seeing offers that are 50% over asking or buyers willing to waive inspection and appraisal contingencies without hesitation.

However, that doesn’t mean buyers have sellers over a barrel by any means. Housing supply is still well-short of the housing demand. Instead, what we’re seeing is a balancing of power, where neither buyers or sellers possess a clear-cut advantage. 

As a result, many buyers are sitting on the sidelines waiting to see if the market will crash, while many sellers are holding out to see if interest rates will come crashing down in the next six months so they can score massive paydays like sellers in late 2020, early 2021. 

This is a mistake.

Trying to time the market (be it the real estate market, the bond market, the stock market, or any other market) is a fool’s errand. 

You should buy (or sell) because it’s what you want to do—you want that new home, you want to change up your investment portfolio, you’re ready to downsize, etc. You shouldn’t buy or sell because you’re trying to squeeze the greatest possible amount of equity out of the deal.

Having said that, the current interest rates do sting, especially when you think they were as low as 3% a little over a year ago. 

Real estate is the hardest hit

The Federal Reserve keeps jacking up its Overnight Rate which is fueling the rising cost of borrowing for home buyers. Unfortunately, the Fed shows no signs of slowing down. As Chairman Jerome Powell said earlier:

“We have got to get inflation behind us. I wish there was a painless way to do that, but there isn’t. We need to see continued slow growth, a modest increase in unemployment, and clear evidence that inflation is moving back down to its 2% target.”

Unemployment remains too low (and inflation too high) for there to be any hope of the federal reserve cutting its rates in the next six to eight months, even though the broader economy is in a recession. 

What the best investors do

Savvy investors don’t try to time the market, but they do watch it. They look for deals and opportunities that make sense within the broader state of the economy. In other words, they look to acquire (or sell) real estate assets at a fair price, no more, no less. 

So, rather than try to time the market at its peak or trough, they do things that allow them to maximize their returns within the framework to the current market conditions. Put another way, they don’t try to beat the market, they simply try to do the best they can with what the current market allows. 

They use hacks that allow them to overcome the obstacles that limit others to give themselves a competitive advantage whether they’re buying or selling. 

The best mortgage hacks to consider heading into 2023

Buydowns
Sellers, lenders, and buyers can use interest rate buydowns to reduce their overall interest rate by purchasing discount points. Whether you’re looking at a 3-2-1 buydown, a 2-1 buydown, or another buydown product, everyone can win. Sellers can get a leg-up on other listings and buyers can make a one-time payment that lowers their interest rate for the life of the loan. 

There’s a lot of nuance to buydowns that we won’t get into here, but one thing that’s critical to note is that a 1-point buydown does not equal a 1% reduction on the interest rate. In the world of buydowns, a 1-point buydown equals a 0.25% reduction in the interest rate. 

5/1 ARMs 
Adjustable rate mortgages are something you’ve no doubt heard of before—especially in the wake of the 2008 real estate bubble. Essentially, a 5-to-1 adjustable rate mortgage allows buyers to lock-in an interest rate that’s below the current 30-year fixed rate for a period of five years. At the conclusion of those five years, the loan rate is allowed to adjust (or “float”) for the remaining life of the loan so that it’s always at the market rate. In other words, if the rate for a 30-year fixed goes up, so does your interest rate and vice versa (though it’s critical to note that the yearly increase will be capped in most, if not all, circumstances).

5/1 ARMs (or 7/1 ARMs) allow buyers to finance a higher amount of the purchase price, control their monthly costs for a five year window, and capitalize on 30-year fixed interest-rate hikes that scare more conservative buyers out of the market. 

15-Year mortgage
Unlike the traditional, 30-year fixed mortgage, a 15-year mortgage allows buyers to build equity in their home in less time and pay off their loan balance faster. Because the monthly payments are higher by the nature of the loan term being 50% shorter, borrowers who take a 15-year mortgage can typically secure a lower interest rate. To put the savings in real terms, if you look at a two loans for the same amount, the day you pay off the 15-year loan, you’d still owe more than 70% of the principal on the 30% year loan. If you can swallow the higher monthly costs, a 15-year mortgage is a great way to lower your total borrowing costs. 

Seller financing
As the name suggests, seller financing is when the home seller finances the deal, allowing the buyer to avoid trying to go through a traditional lender. For sellers, this is an excellent option as it reduces closing costs, increases capital gains tax savings, and offloads operational expenses (e.g., insurance, maintenance, etc.) to the buyer. 

Speaking of the buyer, seller financing makes it easier for them to get flexible borrowing terms, lower closing costs, and (assuming excellent credit) a below-market borrowing rate for the life of the loan.  

Wrap-around financing
Though slightly more complicated than some of the other hacks mentioned here, wrap-around financing (also called all-inclusive trust deed financing) is where the buyer makes a single, large payment that’s then split in two—a portion goes to the lender on the original mortgage and the rest goes to the seller as payment on the new mortgage.

For sellers, this type of financing provides access to a larger pool of buyers, plus, it provides an additional form of income in the way of interest paid to the seller (minus the interest paid to the lender, of course). As for buyers, this is an alternative form of financing that allows them to avoid the rigmarole of going through a traditional lender. It also allows them to avoid lender fees and (hopefully) secure more favorable terms. 

Home-buyer assistance
These are programs designed to help home-buyers overcome common obstacles to ownership, such as soaring interest rates. While there are thousands of different programs across the US, two of the most common are:

• Affordable first mortgage programs—often paired with a downpayment assistance program, this allows buyers to acquire an eligible property at a more favorable interest rate.
• Mortgage credit certificates—a program orchestrated by the federal government that allows first-time buyers to write-off $2,000 of their interest payments every year. 

Though the particulars of these various programs are all different, their underlying purpose is to subsidize the interest rate for qualified buyers. 

Early payoff
This one is pretty much as simple as it sounds—they buyer makes extra payments on their mortgage (even as little as one extra payment per year) to reduce the amount of interest they’ll owe over the life of the loan. As an example, by making one extra payment for year on a 30-year fixed loan (7%, $475K borrowed), the buyer will shorten the life of their loan by six years and save more than $150,000 in payments. As long as you can afford it, the payoff for paying a little extra (or more frequently) is huge. 

Lock and shop
Primarily used for conventional, fixed-rate loans, the “lock and shop” hack allows you to get pre-approved for a loan and “lock-in” the rate for 120 days with you shop for a property—a pretty handy tool in a turbulent rate environment like the one we’re currently in. Once you execute a purchase agreement with a seller, you also have the option to reset the interest rate to current market conditions (assuming it drops while you’re shopping) as long as it’s within 60 days of closing. 

Putting a bow on it

Use the seasonal real estate slowdown to get clear on what you want from your next purchase or  sale.  

Deals will get done when you make an effort to test what you can get against what the other party is willing to give.

Deals won’t get done if you just watch the news, listen to training economists, and sit on the sidelines to “wait it out.”

If you’re a buyer and some of the hacks I shared didn’t resonate with you, don’t get discouraged—you can still buy now despite the high interest rates, as long as you’re nimble enough to refinance two years from now when things are back to normal. 

And for those of you who are still unsure about the hacks shared in this email—or for those of you looking for some alternative hacks not covered in this email—talk to me: ShannonShue@KW.com or 310-853-0335.

Believe it or not, I really am here to help. 

-Shannon