Rising Mortgage Rates Affect Spending
According to Freddie Mac, last week’s mortgage rates continued their upward trend.
Since the election, interest rates have seen more ups than downs.
30-year fixed mortgage rates averaged 4.19 percent, when they were just 3.79 percent one year ago.
But how much do higher mortgage rates really impact how much home you can buy?
What Makes Up Your Mortgage Payment
Your mortgage rate directly impacts your monthly house payment. But it’s not the only element.
Mortgage payments typically include four key components, often called your PITI.
- P = Principle
- I = Interest
- T = Taxes
- I = Insurance
Your principle and interest (P&I) payments are based on a calculation known as amortization, using a mortgage interest rate and a loan amount.
For example, suppose you put five percent down on a $225,000 home, and your interest rate is 4.0 percent with a 30-year fixed mortgage. Using this scenario, your P&I payment would be approximately $1,020 per month.
Add to this P&I amount your property taxes, homeowner’s insurance and mortgage insurance, and you would have your PITI.
Property taxes and homeowner’s insurance can fluctuate over time. However, assuming you choose a fixed rate mortgage, your principle and interest will remain the same over the life of the loan.
The Effect Of A One Percent Rate Increase
The higher your mortgage rate, the higher your payment.
Using the example above, if the maximum principle and interest (P&I) payment for which you qualify is $1,020, a half percent rate rise could diminish your buying power.
Assume the available interest rate has risen from 4.0 percent to 4.5 percent. If your maximum affordable P&I is $1,020, you would now only qualify for a purchase price of $212,000.
- $225,000 x 95% at 4% = $1,020
- $212,000 x 95% at 4.5% = $1,020
Interest Rates At 5 Percent?
If rates increase a full percentage point to five percent, your qualifying purchase price drops to just $200,000.
- $225,000 x 95% at 4% = $1,020
- $200,000 x 90% at 5% = $1,020
Under this scenario, a one percent rate increase would cut your purchasing power by $25,000. That’s a whopping 11 percent negative effect.
These effects typically impact first-time homebuyers the most. If you’re already stretching your budget, rising rates may knock you out of your price range for your starter house.
The table below illustrates specific examples of how rising interest rates impact buying power.
|Buyer’s Purchasing Power|
Don’t Wait for Rates to Come Back Down
A common mistake when rates are on the rise is for homeowners to “just wait until they come back down”.
According to a recent survey by Fannie Mae, only five percent of consumers expect mortgage rates will drop in 2017.
Consumers (and experts) have been wrong before, however. Even so, no one knows for sure what is in store for mortgage rates. The risk involved with trying to time the market could do more harm than good.
If rising rates have already knocked you out of your preferred neighborhood, consider other options:
- Get a cosigner – many loan programs allow non-occupant co-signers. This can provide more qualifying income on your mortgage application. As your income grows, you may find that you’ll “grow into your mortgage” and then refinance your cosigner off the mortgage.
- Buy down the rate – using that $225,000 scenario above, if rates went up by half a point, you could consider paying points to buy down the rate which would reduce your payment. Better yet, get the seller to pay it for you.
- Get a gift for additional down payment – if you don’t have a larger down payment, you may be able to get a gift from a relative in order to keep your payment down. other acceptable sources of funds, depending on the loan program, include loans and grants from governments, charities, and employers.
- Go with an adjustable rate mortgage (ARM) – especially if you don’t plan to be in your home for more than five to seven years, an adjustable rate mortgage may be exactly what you need to get your rate and payment back down to an affordable level.
Mortgage Rates Aren’t the Only Thing On the Rise
Rising rates are just one of the hurdles that could affect your buying power. Property values continue their upward trend as well.
Home prices have risen significantly throughout the U.S. since the housing downturn a few years ago.
From February 2012 through August 2016, the S&P CoreLogic Case-Shiller Home Price Index recorded a home value increase in 64 out of 67 months, up nearly 35 percent nationwide.
With homes continuing to appreciate by more than six percent each year, homes are expected to cost more in 2017.
Let’s apply these housing appreciation numbers to that same scenario from earlier.
Let’s say a home was listed last year for $225,000, putting five percent down, and the interest rate was 3.75% on a 30-year fixed mortgage. Now, that home is priced six percent higher, along with an interest rate that’s half a percent higher at 4.25%.
- $225,000 x 95% at 3.75% = $990
- $238,500 x 95% at 4.25% = $1116
As you can see, the cost of waiting can add up quickly — thanks to home price growth and rising rates – over $125 per month in this example.
What Are Today’s Mortgage Rates?
It’s easy to see how quickly rising rates and increasing home values can impact your purchasing power.
Mortgage rates and home values aren’t showing any signs of letting up anytime soon. If buying a home is in your future, take advantage of today’s still-low rates and home prices before they get much higher.
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