The mortgage rates you find plays a large part in how much money your lender will let you 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 4.0% in 2017. That’s more than 50 basis points (0.50%) higher than the current mortgage rate average.
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
Alimony or child support
Credit card minimum payments
Projected house payment including taxes and insurance
Then divide that number by your your monthly gross income.
Take 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.
Rate Payment Max Price Buying Power Difference
3.875% $1,900 $380,000 $0
4.375% $1,900 $363,000 -$17,000
4.875% $1,900 $345,000 -$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 Is 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.