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Experts say it’s hard to predict what path mortgage rates will take moving forward, but they will depend to a large extent on what happens with inflation and how the Fed responds. Image Credit: AFP

It’s getting even harder to buy a home.

The average mortgage rate recently hit a 21-year record of 7.09 per cent, according to Freddie Mac, significantly increasing the cost of acquiring a home for all but the most cash-rich buyers. That’s more than double the rate of a few years ago.

Here’s what to know about rising mortgage rates and the effect on home buyers.

Why are mortgage rates so high?

Mortgages have become more expensive because of the Federal Reserve’s campaign to get inflation under control.

The US central bank has repeatedly raised the federal funds rate - the interest rate at which banks lend each other money - to increase borrowing costs for everyday people and businesses. More expensive debt, the reasoning goes, means less spending and that should gradually slow the rise in prices.

To a large extent, it has worked: The annual rate of inflation stood at 3.2 per cent in July, far lower than last summer’s peak of 9.1 per cent.

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Mortgage rates tend to move in the same direction as the federal funds rate, although lenders’ efforts to manage risk and expectations for future inflation also play a role.

How does this impact affordability?

Individuals buying houses typically get mortgages, which are loans for the purchase of a home. Home mortgages usually have terms that last 10 to 30 years.

Because mortgages cover such a massively expensive purchase over a loan period that can span a generation, even small differences in the interest rate can make a huge difference in what the homeowner has to pay every month.

Let’s say a home is being bought for $250,000 with a 20 per cent down payment. Holding all else equal, the difference in monthly payment from a 3 per cent interest rate and a 7 per cent rate comes out to more than $500 a month, according to a Washington Post mortgage calculator.

Has this happened before?

Joe Gyourko, who studies the housing market at University of Pennsylvania’s Wharton School of Business, recalls when he and his wife bought a house in the early 1990s. Then, as today, the typical mortgage rate was close to 7 per cent.

But housing prices have risen precipitously since then, and most people’s incomes have not kept up.

“It’s easy for an old-timer like me to say, ‘Ah, I remember rates like these,’” Gyourko said. “But prices were lower relative to income than they are today, particularly in the coastal markets.”

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Rates could be even worse, one analyst said. Mortgage rates climbed throughout the 1970s and reached more than 18% in the early ‘80s before declining.

“High rates are challenging for home buyers, but it’s worth noting that Americans bought homes before the recent era of super-low rates,” said Jeff Ostrowski, analyst at Bankrate.

How long will rates stay high?

“That is the million-dollar question,” said Jessica Lautz, deputy chief economist at the National Association of Realtors.

Experts say it’s hard to predict what path mortgage rates will take moving forward, but they will depend to a large extent on what happens with inflation and how the Fed responds.

Inflation has cooled significantly but still hasn’t reached the Fed’s goal of 2 per cent. Fed chairman Jerome H. Powell has made clear that there is more work ahead to snuff out inflation altogether, even after last month’s 0.25 per cent rate hike. Fed officials don’t know precisely when they will raise rates again, or how long they will hold at the current level.

Does it make sense to buy now and refinance later?

Some real estate professionals have been using the phrase “marry the house, date the rate,” to describe one possible homebuying strategy for today’s market.

The strategy entails buying a house at an unfavorable rate with the hope of refinancing at a later date, allowing the home buyer to capitalize on rising home prices while pivoting to the best mortgage deal available at a given point in time. It can also benefit lenders - they collect fees with each refinancing.

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Experts caution that no one knows when rates will fall. Buyers could be stuck with an unfavorable mortgage for years, warns Wharton’s Gyourko.

“The problem is you need to at least be prepared to also marry the rate,” Gyourko said.

How can I keep my rate as low as possible?

There are a number of strategies home buyers can employ to lower their interest rate, although buyers will always be constrained by what lenders are willing to offer.

One way is to watch your credit score and diligently improve it over time. Credit reporting bureaus track things like the amount of debt you have, missed or late payments on credit card bills, and the length of your credit history. Your credit score can also take a hit from a “hard inquiry” that typically accompanies a loan application.

Pay off as much debt as possible before seeking a mortgage, says Lautz of the National Association of Realtors. Mortgage brokers closely examine the debt-to-income ratio on applications they receive. They tend to view debt-laden households as more risky and thus deserving of a higher rate.

Do these things, Lautz says, “and the bank will look at you as a more favorable consumer, and your mortgage will be better.”