Navigating Higher Interest Rates
With interest rates on the rise, if you are saving it’s great, but not so much if you need to make big purchases. We decided to speak with First Pioneers Executive Vice of Lending, Jeff Fontenot, about how best to navigate this new market.
The Fed raised rates to help with the inflation, recession we’ve been seeing.
So we've been in this high inflationary environment for a couple of years, largely due to the pandemic, and if you've been in the market for a house or a car, you know that prices have risen significantly. The Fed had cut rates really, really cheap to try to spur the economy in response to the pandemic, and because of that, purchases in general just really, really took off. And it forced prices up a lot because you had a whole lot more buyers out there than you had inventory in both homes and cars. And so now we're seeing a situation where the Fed is having to rapidly raise rates, and so of course that's trickling down to lenders having to do the same in order to be able to slow down lending. And with that, we've seen less deposit growth. So that right there is another reason in itself as to why other lenders are having to raise rates is because they're having to pay more money in deposits to be able to get deposits to continue to fund their lending.
Okay. So when we see rates go up like that, don't we find that prices start changing too?
When we see rates go up, then obviously there's going to be less buyers. It's going to start to bring supply and demand a little bit more into balance. And when that happens, then we're going to see prices kind of leveling off. And that's something that we've started experiencing in recent months where we've seen both the housing market and the auto market slowing down a little bit. So we're not seeing as many people having to purchase vehicles for more than the sticker price or the NADA value. And same thing with home purchases. We're not seeing as many people that are having to get into bidding wars and paying $5-15,000 dollars over appraised value just to be able to get a house, where as pretty much all of 2021 and the better part of 2022 we were seeing both scenarios on a regular basis.
I guess it's a good thing that has slowed down some. But people are still going to need cars. They're still going to want to move or need to move where they need a new house. So what kind of recommendations do you have for people that need to make that big purchase?
Obviously, with the higher rates, it's going to reduce your buying power. The good thing about it is that with prices stabilizing like they appear to be doing, you're not forcing yourself in a situation where you have to really make a split-second decision because tomorrow the price might be bid up $5,000 more or something like that. The market is still not anywhere close to being in balance like it should be, but it's better now than what it was just three months ago.
I guess people can still shop for a rate though and find the best rate out there.
Yeah, you still want to shop around and find the best rate out there because you're going to have some lenders that are going to be higher and some lenders that are going to be lower. It just kind of depends on how much they have to lend really. And I mean, more than anything, that's kind of what dictates how much a lender is going to set their rates at is if they have a lot of money to lend in. They are typically going to be a little bit cheaper on their rates because they want to get that money and lend out. If the lender doesn't have a lot of money to lend, then they're going to raise their rates to kind of pump the brakes a little bit on lending. So we always do recommend that you shop around whether it's cars, homes, boats, whatever it is that you're looking at buying just to make sure that you're not jumping into something that would be at a disadvantage to you.
A lot of people might not realize that they may have a credit card or even a loan of some kind that's at a variable rate, which means with these rates going up, the rate they're paying on that card or that loan is going to go up, right?
That is correct. You do have different kinds of variable rate products. On some variable rate products, the payment itself will adjust, depending on the increase or decrease in the rate. Other variable rate products are set at, for instance, a certain percentage of the outstanding balance. For example, our home equity lines of credit, that's how they're set up. So in a rising or decreasing rate environment, the actual payment amount would not change simply because of a rise in the rate or drop in the rate, but you would just have either a little bit larger amount or a little bit lesser amount going to interest than you would had the rise or the drop not happen.
Oh, that's very interesting. I just learned something too. My thought was if you have something that has a variable rate or a higher rate, specifically for carrying debt on credit cards or something, it feels like now is the time to start focusing on paying those down in particular because of that higher rate.
Yeah. And many products out there, credit cards, and also first mortgage loans will have that feature where your minimum payment will change based on the rise or drop in the rate. So you could have somebody that their first mortgage is a $1,000 a month. And if the rates jump as much as they've done in the last year, then that could raise their mortgage payment another $100, $200 bucks a month or something like that. So it is something to be conscious of, particularly in a rising rate environment like this.
Wow, that's a substantial amount too. I've been actually seeing a lot of alternative mortgage products or loan products. In fact, there're several that I wasn't even familiar with. And one of them was the adjustable rate mortgage. Do you have any tips on people that are considering that option when they're buying?
That's a very good question because we do get a lot of questions about adjustable rate mortgages, benefits, drawbacks of them. And I think for me, it's always been just a little bit of a personal nature for me to never recommend adjustable rate mortgages because I’ve basically seen a lot of situations where people were essentially being set up for failure. And regardless of whether you're in a rising rate environment or a decreasing rate environment, I think it's probably better to stick with a fixed rate mortgage because you never really know how long this is going to last.
You could listen to experts say, "The Fed's been raising rates for a year now. They're not going to be raising it that much more. So if you lock in now, then the rates are pretty certain to go down or something." But we don't know. We won't know when the Fed starts lowering rates until we finally get inflation in check. So if you do a three-year adjustable rate mortgage and the Fed doesn't start lower in rates for five years, then you have two years that you're susceptible to fluctuations, big fluctuations, in your mortgage payment there. And so in my opinion, it's not something that I ever recommend to people when they ask me this question.
Now certainly, if somebody has insisted on wanting to do adjustable rate mortgage, we'll do it for them. We'll be happy to do it for them. But as far as something that I would recommend, it's not something that I would recommend. I would always recommend just going with the fixed rate, even if it's an eighth of a point higher or a quarter of a point higher in the rate, which typically it's not. In recent years, they've kind of put the rates a lot closer to one another. But even if it is a small difference there, it's worth it to pay that little bit extra money to have that security because you never know what's going to happen a year, two years, five years from now. So basically, you're paying for that security, that assurance that your payment is going to stay the same. The principal interest portion of your payment will stay the same.
It sounds like it could be potentially fairly risky with the variable rate.
It could be and it could go either way. It could go up. It could go down. We just really don't know. The last time we had a very high inflationary period like this, in the late 70s and 80s, it drug on for a handful of years. So we're only a year into this, that the Feds started raising rates. So if this mimics what happened the last time, then we may have another four or five years left on this before the Fed is at a point where they can start backing off of this. We really don't know. And if you have somebody that takes out a three-year adjustable rate mortgage, then you're only fixed for three years, so you could have two, three years that that rate could go all over the place.
That's good to know. Everybody, keep that in mind. If that's what you're considering or that's what somebody's trying to sort of get you to consider to do, maybe really look at that before you decide to go that way. One other thing I've been seeing is a temporary buydown and to be honest, I'm not familiar with that really at all. What is that?
Rate buydowns is something that has been nonexistent for quite a while because of the low rate environment that we've been in for such an extended period of time. This is something that we are seeing make a recurrence again because rates have risen so much over the last year. What I would recommend, is that if you're considering buying down your rate that you need to speak with your lender to find out exactly how much this is going to cost and figure out the pros and the cons of doing this; how much money you're going to have to spend in order to get this lower rate versus how long you feel that you may have this mortgage. Of course, no one ever completely knows unless you plan on just buying the house for a short period of time and selling it. But that's really something that you've got to look at on a case-by-case basis, rather than just trying to speak in general terms.
So that's something that people are really going to need to consider and make sure they have all the facts before they use that option.
That's correct.
Good to know. I also hear a lot of people talk about using their using a HELOC - which is home equity line of credit, or a home equity loan to maybe pay down other debt. Which is fixed rate and which is variable rate, and is that really a good idea?
Typically, a regular home equity loan, will be a fixed rate of interest. It's a closed-in loan, so it's set for a fixed term just like any first mortgage would be. You make the payments on it and after a set term, whether it's 5, 7, 10, 15 years, whatever it may be, it's paid and it's done. A home equity line of credit is similar to that of just a regular line of credit where you can draw money on it, you can pay it down. You can draw money on it, pay it down, and the only difference is that it's secured by the equity in your house. One of the things that I always caution people, whenever they're inquiring about that, is just to keep in mind that if you're transferring this debt from an unsecured debt, like a credit card, unsecured loan, whatever it may be, to your home equity, that you are putting your home at risk for that if a job loss, illness, something like that were to occur. From a cost-saving perspective, obviously it is going to save you a significant amount of money to do that because typically with home equity, you can bundle in a much larger amount. Whereas maybe just getting a small $10,000, $15,000 personal loan, you might be able to get $50,000 or something like that. It just depends. But as far as home equity loans, we usually see that the two biggest reasons that we see people applying for home equity loans are consolidating debt and also doing home repairs, where they're basically using their home equity to put that money back into the home. Whether they're adding something onto it, renovating a kitchen or a bathroom, whatever it may be. Building a shop in the back of their house. Things like that.
It's another one of those times that, let's consider the risk before you jump into something like that. Maybe even look at all your other options before you just automatically go to your home equity, I guess.
Correct. And it's also one of those things where everybody's situation is different, so there's no one-size-fits-all for a lot of things like that. It's really good to talk to your loan officer and just have them sit down, look at what your debts are, look at what your equity is, look at what you're paying, and make a little bit more informed decision than just saying, "Oh, well, I need to consolidate all of this. Let me just go ahead and do a home equity loan and just stick it all in there."
Very good advice. Let's see. One other one that I've been seeing is a loan assumption. What exactly is that?
Loan assumptions are where somebody has a home they have a mortgage that they're paying on and they want to sell the house, and the lender allows the purchaser to assume their existing loan. I know back in the day, those were a lot more common than they are now. Most lenders now, including us, will require that the loan be paid in full and whoever it is that would be purchasing the home would have to get and qualify for their own loan themselves. But back in the day, those were a lot more common than they are now.
The last one that I had seen and I've seen people do these before, maybe they're renting a home or something. And then they do some kind of rent-to-own type situation with the owner of the home. Is there anything they need to look out for something like that?
There's a few different options that you have where you have a rent-to-own. You can sign a lease purchase agreement, where you may have an agreement to lease the house for a year, and then have an option to purchase it at either a set price or a price mutually agreed upon at that time whenever the lease is running out, depends on how the contract is written. You also have what they call in Louisiana a bond for deed. And that is a contract itself where the buyer and the seller will enter into a contract where the buyer will make payments to the seller of a set amount for a certain amount of time until a certain price is satisfied and then at that time, once the entire price is satisfied, then they will get an active cash sale done to transfer the property over into the buyer's name. But while they're under the bond for deed contract, the property still stays in the seller's name so that in the event that the buyer were to default, it's a little bit easier for the seller to get that property back because the property is still in their name. Those are two common options that a lot of residents in Louisiana will enter into when they don't want to go the traditional mortgage route. And there's different situations out there that would bring light to each one individually. For example, the lease-purchase agreement, you may have somebody that likes a particular area that says, "I'd like to try out that area, see how it is," and then they go over there, they move in, they start leasing the house, and then they realize, "You know what? There's a train track that's two miles away and every night at 11:30, a train passes and blows the horn and it's annoying. It wakes me up. And I don't like it." Or they may get a lot of loud traffic on the road or something. And they say, "No, I don't want to do that." Well, in that case, then at the end of the 12-month lease, assuming that that's what they put into the lease-purchase agreement, then they can just walk away from it. They're not bound by anything. Whereas if you buy the house and you didn't realize that that train track was two miles away, or you didn't realize that there was a lot of loud traffic on the road at night or something like that, then you're kind of stuck for at least a little while there. There's a whole lot of different situations that would bring forth different options there to not go the traditional mortgage route right at the time of purchase-- or right at the time of moving into the property.
Oh, okay. That's actually a really good option if you want to kind of test drive a neighborhood or something. I never would've thought of that. One thing I know you and I have talked about before is balloon payments because I know you don't love balloon payments. Do you want to talk a little bit about that and how that might trip some people up?
You're right on that. I'm not a fan of balloon payments because I've seen situations before where someone has gotten a loan, and say, for instance, they're on a five-year balloon and, at some point during the five years, maybe they had a job loss. Maybe they had an illness, something like that, that caused them to get behind on some bills. And now, five years later, this balloon is coming due and they still have not reestablished themselves to the point that they can qualify for decent terms. So now they're in a situation where they either have to accept less favorable terms than what they had to begin with or they can't get financing to be able to refinance the balloon mortgage and they lose the house. Now, typically, a local lender is going to try to work with them as much as possible to avoid that because the local lender doesn't want the house. But if it's a larger nationwide lender or something like that, they might be a little less likely to work with them and give them that consideration. So that's always been my caution whenever people have asked me about balloon payment loans. And, again, similar to what we discussed with the adjustable rate mortgages earlier, it's another reason why I always default back to the fact that it's better to just go ahead and take the fixed rate mortgage. Even if that rate is an eighth of a point or a quarter of a point higher, you're paying that little bit more money in interest every month to have that security to know that you're not going to be running into a situation where you may lose your home. As long as you make your payments every month, you're going to be okay.
I think sometimes people don't think about that. They're caught in the moment of, "Well, this is what I can afford now," or, "This is going to get me out of the situation I'm in now," but it doesn't take into account what may happen in the future.
That's correct. And something to be conscious of is that you're entering into something that's going to be a 20, 30year agreement. So it's always good to think longer term rather than shorter term because a lot of things can happen over the course of 20, 30 years. There's a whole lot of life events that can happen. It always reinforces my stance on the hybrid options, that it's probably just a good idea to stay away from them. Everybody is different. Everybody has different tastes and everything like that. But just my personal opinion, it's a always a good idea to stay away from them.
I think I agree with that. Okay, so are there any other ideas that you want to throw out there to help people out?
One of the questions that I get asked a lot is 15 year, versus 20 year, versus 30 year mortgages. If you've ever looked into getting one, priced them out, you've noticed that 15 year is going to be cheaper than a 20. 20 is going to be cheaper than a 30. Going back to what I was hitting on just a minute ago about life events and not knowing what we can predict in the future. What I always recommend is that you not get yourself in a payment that is uncomfortable. If you're looking at getting a 15 year mortgage and you can swing it comfortably, then I'd say, "You know what? Go ahead and get it by all means. You'll pay a little bit lesser interest rate. You'll save some money. And everything will be great." If you're looking at getting a shorter-term loan like 15, 20-years, and it's really going to stretch your budget to the max, then you would probably be better off getting that 30-year loan and paying a little bit extra money on it every month to maybe try to knock it out in 20 years or something like that. Rather than try to be stretched every month to try to get that 15, 20-year loan. Because again, you don't know what life events are going to throw at you. You don't know if you're going to get sick and need surgery and have to pay a $1,500 deductible out of pocket. You don't know if you're going to have to change the air conditioner on your house or change the water heater or something like that. Things are going to just pop up, whether it's something around the house, whether it's a repair on a vehicle or something like that.
So I always recommend to people, never put yourself in a situation where it's going to stretch your budget thin.
Yeah, I think a lot of people don't think about that, that just because your mortgage says 30 years, you can make extra payments. I know a couple of people that had a 30-year mortgage that paid it off in 15 because they were making extra payments. So there's always options that you can explore.
Exactly. It's very rare that you see somebody take out a 30-year mortgage and that mortgage go to full-term because most everybody usually tries to throw a little bit on there. Whether it's once a year when they get a bonus at work or they get their tax refund and throw a little bit of extra money on there to try to shave several years off that term. It's very common.
Right. Probably more common than people realize.
Exactly.
One other thing… Anytime you're making a large purchase, car, home, whatever it may be, always make sure to never get in a hurry. Take your time, do your research, ask your questions, shop around a few different lenders. Make sure that you're making an informed purchase and you're completely in the know before you sign your name on any paperwork.