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How Rising Interest Rates Impact What Price Home You Can Buy

Written by Posted On Wednesday, 07 February 2018 09:08

Over the past several weeks, mortgage rates have increased .250% to .500%, depending on the mortgage program and lender, and are approaching a multi-year high.  Although the Federal Reserve did not raise the Federal Funds rate at its January meeting, several interest rate increases are expected this year due to the robust economy and job market.

 

Usually when the Fed raises interest rates it means the economy is strong -- unemployment is typically low and wages are increasing -- which is positive if you are in the market to purchase a home.  The other side to this favorable economic news is that higher interest rates make it more challenging to buy a home.  For many prospective buyers, buying a home feels like a moving target -- you feel good about your job, you are earning more money, you are finally ready to buy a home -- but higher mortgage rates make it more challenging to qualify for a home loan.  But how much more challenging?

 

Below, we use an example to demonstrate how an increase in mortgage rates affects what size mortgage you can qualify for.  In the example, the borrower earns $60,000 a year in gross income, or $5,000 a month, and has $500 in monthly debt expense such as credit card, car and student loan payments. (Use this Mortgage Qualification Calculator to determine what size mortgage you can afford based on current mortgage rates).  

 

The graph shows how much mortgage the borrower can afford based on different mortgage rates -- the higher the mortgage rate, the lower the mortgage amount the borrower can afford.  At a 4.000% mortgage rate, the borrower can afford a $332,635 home loan while at a 6.000% mortgage rate, the borrower can only afford a $264,843 home loan.  Although we do not expect that interest rates will hit 6.000% this year, this example demonstrates how increasing mortgage rates affect how much mortgage you can afford.

 

 

Taking the example one step further, let’s review how an increase in mortgage rates impacts what price home you can buy.  Using the same scenario as above, the graph below shows what price home the borrower can afford, assuming the borrower makes a down payment of 20% of the property purchase.  While it is certainly possible to buy a home with a lower down payment (review these no or low down payment mortgage programs), a 20% down payment typically enables you to receive a lender’s lowest mortgage rate.  The graph shows how rising mortgage rates reduce what price home you can buy.  At a 4.000% mortgage rate, our example borrower can afford a $415,794 home while at a 6.000% mortgage rate, the borrower can only buy a $331,054 home.

 

 

The analysis makes it pretty clear that higher mortgage rates do not help prospective home buyers, but let’s understand the issue from another perspective.  For example, let’s say you already know the home you want to buy but you need to determine if you can afford the mortgage to buy it.  In this example, the home costs $250,000 and you plan to make a 20% down payment ($50,000), which means you need a $200,000 home loan. But can you afford the monthly mortgage payment?  The answer depends on the mortgage rate.  The graph below shows the monthly mortgage payment for a $200,000 home loan using a range of interest rates.  The graph shows how higher mortgage rates increase your monthly mortgage payment.  At a 4.000% mortgage rate, the monthly mortgage payment on a $200,000 30 year fixed rate home loan is $955 while at a 6.000% rate, the monthly mortgage payment is $1,199.  So depending on how much money the borrower earns, the higher mortgage rates and monthly payments may make the home unaffordable.

 

 

It is important to emphasize that it is impossible to predict mortgage rates.  Although most industry analysts expect interest rates to rise in 2018, a number of economic events could produce a different results.  Understanding how rising mortgage rates impact what size mortgage you qualify for and what price home you can buy eliminates surprises and best positions prospective home buyers, regardless of what happens to interest rates.


This article first appeared on FREEandCLEAR.  For free mortgage resources and rates please visit FREEandCLEAR.com.

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Michael Jensen

Michael H. Jensen is the co-founder of FREEandCLEAR, a leading mortgage website that enables borrowers to find the mortgage that is right for them.  FREEandCLEAR’s mission is to empower borrowers to make better mortgage decisions, save money and avoid getting ripped off.  To become an informed mortgage borrower visit www.freeandclear.com.

https://www.freeandclear.com/

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