What Rising Rates Mean for Homebuyers

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NEW YORK (MainStreet) — A year ago, most economists and market experts said interest rates would rise in 2010 as the economy got stronger. It took longer than most predicted, but rates have begun to nudge up. And now the seers say rates will go even higher in 2011.

That could be good news for savers, but not such good news for mortgage shoppers and other borrowers.

The Wall Street Journal found in a survey of 17 bond dealers that the expected average yield on the 10-year Treasury note is projected to rise to 3.5% by the end of 2011, compared to 3.4% today and 2.4% in early October. Three of the firms surveyed said the yield could go as high as 4% and one forecast 5%.

None of these rates is very high by historical standards, but a couple of years ago, the rate was down around 2%. Rates are still so low there’s a better chance they’ll go up than down.

For fixed-income investors, it might be a time to emphasize bank savings over bonds, as a bond purchased today would lose value if newer bonds offer better yields next year. Investors with bond funds should look to a figure called “duration,” which estimates how much the fund’s share price would fall if interest rates went up. A five-year duration, for instance, means the fund could lose 5% of its value for every one-point rise in prevailing rates. The shorter the duration, the lower the risk.

While bond funds, especially long-term bond funds, pay higher yields than bank savings, interest earnings could be wiped out by falling bond prices. With bank savings, principal is insured against loss, making savings a safer bet during periods of rising yields.

And, if you are lucky, bank yields may improve in the coming year. If you want to bet on that, it probably makes sense to stay flexible. Five-year certificates of deposit average 1.582%, according to the BankingMyWay survey. While that’s a lot better than the 0.252% paid by the average money market account, you might do better during the next five years by using the money market now and waiting a few months for CDs to pay more.

Borrowers, of course, want to do the opposite by locking in today’s low rates. Rates on 30-year fixed-rate mortgages have gone up a bit recently but are still an awfully good deal, at about 4.8%. If they were to rise to 6%, a $100,000 loan would cost $600 a month instead of $525, according to the BankingMyWay Mortgage Loan Calculator.

So anyone thinking of refinancing a mortgage should probably get moving. BankingMyWay's Refinance Breakeven Calculator can help you figure whether getting a new loan is worth the cost.

Home shoppers are in a tougher position, meanwhile. While you might get a cheaper mortgage today than in six or eight months, the housing market is still pretty risky. Prices are continuing to fall in some areas, so a home bought today could be worth less later, wiping out any benefit of getting a cheap mortgage today.

Whether a home purchase makes sense depends entirely on the local market. If unemployment is not increasing, the supply of foreclosed properties is not increasing, and prices seem to have stabilized, then a purchase may be a safe bet.

More than ever, though, the key to making a home purchase work out financially is your long-term plan. If you expect to stay for at least six, seven or eight years, your chances of breaking even are pretty good, even if there is a slight dip in home values just after you buy. But this is probably not a good time to buy a home if you expect to move in three or four years.

—For the best rates on loans, bank accounts and credit cards, enter your ZIP code at BankingMyWay.com.

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