Your Mortgage Rates Affect Home Affordability
The Importance of Mortgage Rates
The mortgage rates you find play a large part in how much money your lender will allow you to borrow. That affects how much home you can buy. That begs the question: how does your purchasing power change if rates creep up a half a point or even one full percentage point? Much more than you might think, which is why it pays to shop for a home now, and lock in a favorable fixed rate at historical lows.
Many home buyers realize that rising home prices can limit their ability to buy. However, rising interest rates can alter home-buying plans even more. The current rate environment is likely a narrow window of opportunity in which to claim a low rate and a still-reasonable home price. Housing agency Freddie Mac recently predicted that mortgage rates will rise to 5.0% by 2020. That’s more than 50 basis points (0.50%) higher than the current mortgage rate average.
Debt to Income Ratio Explained
Today’s lenders qualify home buyers based on several factors, not the least of which is something called a debt-to-income ratio (DTI).A low DTI demonstrates that you have a healthy balance between income and debt.Lenders generally cap the allowable DTI at approximately 45% for conventional loans.
To determine DTI, add your total monthly debt obligations including the following items:
- Car loans
- Student loans
- Alimony or child support
- Credit card minimum payments
- Projected house payment including taxes and insurance
- Then you simply divide that number by your your monthly gross income.
In the following example, a loan applicant (we’ll call him Steve) has a monthly gross income of $5,000 and expected total monthly debt of $2,250. His DTI is 45% in each scenario.
Scenario ONE Rate:3.875% | Payment:$1,900 | Max Price Buying Power:$380,000 | Difference:$0
Scenario TWO Rate:4.375% | Payment:$1,900 | Max Price Buying Power:$363,000 | Difference:-$17,000
Scenario THREE Rate:4.875% | Payment:$1,900 | Max Price Buying Power:$345,000 | Difference:–$35,000
As rates rise, Steve’s buying power decreases significantly. Rising rates can hurt buying power even more than increasing home prices. In most U.S. locales, home prices would probably not rise more than 10% in one year. However, if rates rise by one percent in one year, the effect is the same.
What’s the Risk of Waiting When Mortgage Rates Increase?
If the interest rate increases 1%, this would likely put many buyers out of the market. That’s because the typical buyer would need to look at homes that cost about thirty-five thousand dollars less, if rates rose by one percent. Consider that $35,000 is usually the difference between an extra bedroom they need or a certain zip code with better schools or an older home versus a newer home.
There’s Another Cost to Waiting, Too
Home values are rising in most areas of the country, so today’s nice $300,000 starter home is likely to cost over $320,000 a year from today. Buyers will be ahead of the game by getting into the market today.
Rates are at one of the lowest levels in the history of the United States, and waiting for them to get lower is a huge gamble. Another thing to remember is that, as mortgage rates increase, the amount of principal paid down every month decreases. More money in the early years of the loan goes toward interest, which makes higher mortgage rates even less desirable.
If you’ve decided to buy a home but are not sure when you should, it could be time to take action.
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About the Author: The above article, Mortgage Rates Affect Home Affordability was written by Troy J. Elston, a licensed Realtor at West USA Realty, the premiere real estate brokerage based in Peoria Arizona. With years of experience in the real estate industry, Troy produces stunning results for home buyers and sellers. If you’re thinking of BUYING or SELLING a home in the Phoenix Area, Troy would love to share his knowledge and expertise with you.