It's crunchtime for homebuyers. Mortgage rates are at 21-year highs. And home affordability is the worst it's been since the early 1980s. The fallout? Potential homebuyers find it hard to make the numbers work.
To solve this daunting math problem, many home shoppers are employing a buy-now, refinance-later strategy to get the keys to their dream home.
Here's how it works: They stretch their budget now and purchase a home at current borrowing rates with plans — and hopes — to refinance their loan at a lower rate in the future. The goal, of course, is to improve affordability.
But this strategy — which popularized the saying "Marry the house, date the rate" — carries risk.
Think Twice About Sky-High Mortgage Rates
In a nutshell, many homeowners (especially ones who will struggle to make their mortgage payments at the higher rate), are betting mortgage rates will fall to alleviate their budget crunch. The average rate on a 30-year fixed mortgage hit 7.09% recently, its highest level since 2002, according to Freddie Mac.
Is it a risk worth taking? For cash-strapped homebuyers, probably not, personal finance experts say. For people with deep pockets who can afford the higher payments from the get-go, it's less likely to cause financial problems.
"I think it's a pretty risky proposition to approach a home purchase with the notion that I can sort of tread water for a couple of years with the hope I can refinance later," said Mark Hamrick, senior economic analyst at Bankrate.com.
Sure, it's possible the strategy will work, but what if it doesn't? "It could have a tragic outcome," said Hamrick.
Know What Mortgage Rates You Can Afford
Just because your real estate agent and lender tell you that you can afford the house, that doesn't mean you really can, adds Hamrick. "Once you close, they're not going to help you make the monthly payments," he said.
There are several problems with betting the house on rates falling. First, rates may not fall. It's hard to predict with any degree of confidence which direction mortgage rates are headed.
"Interest rates could go down, they could go up, or they could stay elevated for a long period of time," said Brian Walsh, a financial planning expert at SoFi.
If rates don't come down, it can mean homeowners are living in a house they can't afford. And, if they can't lower their monthly mortgage costs via a refinance, that can bust the family budget and cause a variety of other money problems.
In a worst-case scenario there's a risk that a homebuyer will default on the mortgage and risk losing the home, warns Hamrick.
Be Careful What You Wish For
What's more, if rates do fall, it's often due to the economy losing steam. And that's not necessarily a good thing, either.
"That probably means people might be getting laid off," said Zack Chamberlain, a wealth planner at investment firm Robert W. Baird. And it's hard to get approved for a home loan if you don't have a job or steady income.
Remember, personal finances face pressures if you stretch too much. A sound home purchase is one in which the buyer can fund the down payment and be able to make the monthly payment month after month from free cash flow, says Walsh.
"The monthly payment needs to fit comfortably into someone's budget right now," said Walsh. Not one or two years from now.
It's More Than Just Mortgage Rates
And don't forget about the non-mortgage-related expenses of owning a home, such as replacing aging roofs and appliances. And then there's paying the monthly bill to heat and cool the home and keep the lights on.
Indeed, the risk of stretching for a home now can lead to unintended consequences later.
"(You don't want to) rack up credit card debt, eat into your emergency fund or skip saving for retirement," said Walsh. "That can put you in a pretty big financial bind."
And suffering a cash crunch isn't ideal for most people. Only 43% of Americans say they can pay for a $1,000 emergency expense with savings, according to a Bankrate survey.
"You've got to have some money left in reserve to account for the unexpected," said Chamberlain. "And you don't want to deplete your nest egg, either."
Don't Stretch With Mortgage Rates
Rather than stretch for a home you really can't afford due to high mortgage rates, you're better off delaying your purchase or buying a smaller home that fits your budget, says Chamberlain.
"Higher rates might mean someone's not able to afford the four-bedroom home that they have their heart set on," said Chamberlain. "It might require them to figure out if a three- or two-bedroom home is sufficient."
Refinancing Isn't Guaranteed
Refinancing a mortgage only makes sense if rates fall below the level of your current home loan. So, if rates stay higher for longer, as some economists forecast, refinancing may not be an option.
It's not cheap to do a refinance, either. Costs typically range from 2% to 5% of the loan amount. "Refinances run in the thousands of dollars," said Hamrick.
There's also a risk that home prices will decline, which could make it more challenging to refinance. Why? If the price of your home falls, it could result in you owing more than the house is worth or having less equity than the lender requires, which makes it harder to get approved for a loan. "Housing prices don't always go up," said Walsh.
Of course, if you must buy a house now due to a job relocation or the need for more space, waiting to buy because rates are high could end up costing you more if home prices keep rising, experts say.
