Can I count on rates lowering in the next two to three years? What should I do now?

What do gravity and mortgage rates have in common? What goes up must come down. Unfortunately, there’s no foolproof scientific formula for making mortgage rate predictions for the next five years or more. But it can be helpful to understand the general context of how mortgage rates change so that you can strategize and prepare for whatever comes down the pike.

What is the future of mortgage rates?

Albert Einstein coined the phrase: “If you want to know the future, look at the past.” From 1971 to 2022, the average 30-year fixed mortgage rate was 7.76 percent. In that time, rates have climbed to over 18 percent (in 1981) and dropped below 3 percent (in 2020) – with many variations in between.

What does this history lesson tell us? Mortgage rate fluctuations are normal and relatively unpredictable. While experts certainly try to make interest rate predictions, it’s important to remember a forecast is just that – an estimate. What we do know is that rates are based on many different factors: economic conditions, the housing market, the Federal Reserve’s benchmark rate adjustments (which indirectly affect mortgage rates), and more.

What does that mean for you?

It’s easy to get hung up on questions surrounding rates. Are interest rates rising? Will mortgage rates go down? But remember, interest rates are just one factor in the cost of a mortgage. How much you’ll ultimately pay for a home will come down to many other variables including the purchase price, down payment, loan term, and closing costs.

Even if rates come down in the next few years, it may make sense to buy now if you can afford it. Here are some options that may help you decide.

Option 1: Go for an adjustable rate

An adjustable-rate mortgage (ARM) is divided into two periods. First, it has a fixed rate for a set number of years and then the rate fluctuates based on the market for the remainder of its term. ARMs are popular when rates rise for two key reasons:

• The introductory rate is typically lower than any fixed-rate mortgage options.
• Your payments can decrease if rates go down during the variable period.

For example, say you get a 3/1 ARM for $500,000 and an introductory rate of 7 percent. When your introductory period ends in three years, rates have lowered to 5 percent. See how your monthly payment changes:

That’s over $600 in savings each month and over $7,000 for the year. Of course, there’s always a risk that rates will go up instead. For that reason, it’s important to know exactly how ARMs work and consult with your lender before you make the call.

Option 2: Buy now, refinance later

Locking in a rate for a 30-year mortgage can sound daunting, especially when the rate is higher than you want. While it’s important to see a mortgage as a long-term commitment, the fact of the matter is that your terms are not set in stone. Refinancing is a tool you can use to change your rate and term (and even get cash back) if the time is right. It’s typically recommended to refinance when you can reduce your rate by a full percentage point – but it sometimes makes sense to do so to save less than a full percentage point.

Let’s say you lock in a 7 percent rate on a 30-year fixed-rate mortgage for $500,000. In two years, rates are down to 6 percent. When you run the numbers, you see that you’ll save almost $400 per month and over $61,000 in interest over the life of the loan.

Just keep in mind, refinances also include closing costs. You’ll want to be sure to keep the mortgage long enough to make the upfront expense worth it.

Option 3: Ride it out

If buying or refinancing aren’t a high priority for you right now, then the smartest action might be no action. Or rather, play a longer game: Save now for a larger down payment later. Improve your credit score if there’s room for improvement. When the time comes to apply for a mortgage, both actions can help you qualify for a lower rate and potentially save thousands of dollars over the life of the loan.

What should I do?

Truth is, there’s no crystal ball to determine if interest rates will go down. It’s hard to make a decision without knowing the future of mortgage rates. Instead of focusing on external factors, it can help to look inside your own situation to determine if the time is right. If you can afford a mortgage at its current rate – knowing you can still take advantage of future rate reductions – it may be worth moving forward now.