As the U.S. Federal Reserve contemplates whether to cut interest rates this week, mortgage rates may also follow suit, depending on how the industry reacts.
Mortgage rates are set by banks and similar financial institutions based on broader economic influences. The yield on the 10-year treasury bond is one of them, alongside the Fed funds rate and other metrics.
Why is this important? A decline in mortgage rates could present new opportunities for buyers normally priced out, including people who are low-income or purchasing for the first time. Homeowners would also have opportunities within their budget to refinance or move into a larger home.
Let's explore this potential growth and determine how would-be first-time homebuyers can take advantage of new opportunities to build generational wealth.
A compounding positive impact that starts with first-time buyers
Elevated mortgage rates are one of the main factors that are keeping new homebuyers from entering the market. The average price of a new house is $389,000, according to a Homes.com report on U.S. price growth. That can be a stretch for many first-timers, who typically don't have the capital to purchase a property without financing. And the cost of that financing, the interest they pay, can make or break a budget.
"First-time buyers often pause because monthly payments no longer fit their budget," Brian Hurd, senior vice president, National Builder at Cardinal Financial Co., told Homes.com. "Lower rates are one of the catalysts that reconnect supply and demand, [assisting buyers'] first step into homeownership while giving builders the confidence to create new inventory."
Those incentives added tens of thousands onto the cost of a new home, Hurd said. So, while rates dropped over time, the cost of construction rose dramatically.
Lower mortgage rates would help first-time buyers afford mortgage financing, which would incentivize more applicants to enter the market and buy up inventory before it becomes more expensive.
"For buyers who are priced out, usually first timers with little or no equity and lower incomes, lower mortgage rates would help to make things more affordable and stimulate sales," said Carl Gomez, chief economist for CoStar Group, the parent company of Homes.com. "This, in turn, would help to make the rest of the market move forward. First-time buyers are the grease that makes the housing market spin."
Lower monthly principal-and-interest payments
Lower mortgage rates would also help by decreasing monthly principal-and-interest payments for the same loan amount, according to Jeffrey M. Ruben, president of WSFS Home Lending at WSFS Bank. That creates two primary impacts:
"It brings some buyers who had been priced out back into the market, and it makes upgrading more affordable for homeowners who want a larger or different home," Ruben told Homes.com. "When rates drop, the housing market usually sees more buyer traffic and a greater number of successful offers."
Here's an example of how a lower mortgage rate can cut your monthly payments down to size:
Let’s say you put $80,000 down on a $400,000 home. The 15-year fixed loan amount is $320,000, and your mortgage rate is 5.6%. Your monthly payment would be $3,172. That equates to $1,139 a month in principal payments and $1,493 in monthly interest payments.
After a rate cut, the mortgage market reacts and the average mortgage rate for a 15-year fixed loan drops to 3.5%. Your monthly payment would fall to $2,828. That breaks down to $1,355 in monthly principal payments and $933 for interest payments.
While your principal payments go up, your overall monthly payment amount and interest payments would decrease dramatically. That increases affordability while helping you keep money in your pocket.
Opportunities for sellers, move-up buyers and people refinancing
Sellers, move-up buyers and people refinancing their mortgages would also see more opportunities to sell their current homes and pursue alternative options.
In the past, higher rates led move-up buyers to back off from selling their homes and stay put to hold on to low, legacy rates.
"Replacing their lower rate with a higher rate would have increased their monthly costs," Gomez said, adding they would delay a move they might otherwise make. "This effectively reduced housing inventory and contributed to higher home prices, leading to further deterioration of affordability."
"Eventually the market will also see a spike in listing activity because the 'lock-in' effect eases –- meaning, owners who had ultra-low rates feel less financially punished for selling," Ruben said.
Specialized assistance programs become more potent
If mortgage rates come down, programs like down payment assistance (DPA), federal housing administration (FHA) loans and U.S. Department of Agriculture (USDA) loans potentially would benefit first-time buyers more.
"Lower rates boost the effectiveness of down-payment assistance, income-based programs and reduced-payment loan products because the monthly cost is lower," Ruben said.
"This creates more opportunities for younger or first-time homebuyers because it means those with small down payments or debt burdens can qualify for a larger loan or a monthly payment," he added.
Mortgage lenders also may refer buyers to assistance programs during the financing process.
"We work every day to connect buyers with these options and guide them through the process," Hurd said. "We also partner with builders focused on attainable housing, including manufactured and entry-level communities."
What should first-time buyers do to take advantage of lower rates?
First and foremost, first-time buyers should check their finances before preparing to buy a home. "That includes a proven track record of stable income, little overhead from debt and a good credit score," Gomez said.
Preparation should start immediately. First-time buyers specifically need to be proactive with improving their financial profiles.
Here are the steps you should follow, according to experts:
1. Boost your credit score
For first-time buyers, the first step should be boosting your credit score. With this step, proactivity is key. And the results could set you up for success.
"You'll want to boost your credit score and clean your credit file by lowering debt balances and avoiding new credit inquiries," Ruben said. "Stronger scores translate to better pricing when rates drop, and a lower debt-to-income ratio makes you more likely to qualify for the mortgage you want."
2. Build up your savings
Having a sizable down payment is essential for decreasing your monthly mortgage payments. It also opens doors for first-time buyers.
"Increasing savings for a down payment widens program options and gives you more bargaining power with sellers," Ruben said.
3. Understand the different loan programs
Once your finances are in order, you must have a firm understanding of the different loan programs that you may be offered, and what they include.
"Some elements include fixed versus adjustable rate, term length, down-payment assistance and more," Ruben said.
4. Get preapproved and run scenarios with a lender
The last and most important step is to get preapproved with an eligible lender. Running a rate drop scenario is another valuable step to save you money before a potential refinance arrives down the line.
"Ask your lender to run scenarios, so you know the break-even points if rates shift by 0.5% or 1.0%," Ruben said. A break-even point is when you save more than you spend by refinancing your home.