Mortgage Rates and Your Purchasing Power

Mortgage rates have increased significantly this year, and over the past few weeks, they’ve been fluctuating quite a bit. It feels like we don’t go a day without reading a new headline about interest rates.

What have rates done this year?

We started 2022 with the average 30-year fixed rate at 3.31% in January. By April, that was up to 4.88%. We saw rates hit a 14-year high in June at 6.28% on June 14. While things seemed to steady in July and rates dipped back down to 5.41%, we saw an increase in August and we ended the month at 5.99%. **Revising as of this morning, we are back up to 6.23% (Thursday, September 1).

According to Matthew Graham with Mortgage News Daily,

“The last day of August was also the worst day for rates in August. In fact, it was the worse than any of July as well and not too terribly far from the 14-year highs seen in June. The average lender is only about a quarter of a percent to 0.375% away from the levels seen on June 14th (the 14-year high day).”

While it’s hard to predict where rates go from here, Freddie Mac and the National Association of Realtors are forecasts rates of 5.5% and 5.8%, respectively, by the end of September.

What does this mean for you?

If you’re planning to buy a home, it’s critical to understand the relationship between mortgage rates and your purchasing power. Purchasing power is the amount of home you can afford to buy that’s within your financial reach. Mortgage rates directly impact the monthly payment you’ll have on the home you purchase. So, when rates rise, so does the monthly payment you’re able to lock in on your home loan. This impacts how much house you can afford to purchase, because when qualifying you for a loan, your lender has a specific debt-to-income ratio they have to stay within. If your monthly payment goes up because rates have increased, that will impact your debt-to-income ratio and you’ll have to put more down or buy less.

It’s important to stay up to date on what’s happening with rates and understand how they can impact your purchasing power when you’re thinking of buying a home. The chart below can help.

Let’s say your budget allows for a monthly mortgage payment in the $2,100-$2,200 range. The green in the chart indicates a payment within or below that range, while the red is a payment that exceeds it.

As the chart shows, even a small change in mortgage rates can have a big impact on your monthly payments. If rates rise, you could exceed your budget unless you pursue a lower home loan amount. If rates fall, your purchasing power may increase, which could give you additional options for your search.

For Example

For example, if Johnny Home Buyer wants a 5% rate on a 30-year fixed mortgage on a home worth $400,000, his monthly mortgage payment would be $2,147. But if Johnny only qualified for a 6% rate on a 30-year fixed mortgage, his monthly payment would rise to $2,398. A 1% increase in interest raises Johnny's payment by $251, or roughly 12%. So, what does this mean for homebuyers?

From a home buyer's perspective, as mortgage rates increase, affordability decreases. In the aforementioned example, Johnny Home Buyer wants to qualify for a $400,000 mortgage at 5% interest, but at 6% interest, lenders can only offer Johnny a $360,000 loan based on his qualifications. A 1% increase in mortgage interest decreases Johnny's purchasing power by $40,000. On a smaller level, that means for every 25 basis point increase (0.25%) there’s a drop in Johnny’s purchasing power of ~$10,000.

A more expensive house in the above example would experience an even greater purchasing power drop. With a 1% increase in interest rates, this would be ~$55,000 drop in purchasing power on a $600,000 house. (So ~$13,750 for every 0.25%). Tying this all together, if the jump from this morning from 5.99% to 6.23% occurred, Johnny Home Buyer may only be able to offer $597,000 on a $600,000 instead of $610,000, which can be the difference between winning and losing.

Work with Trusted Advisors To Know Your Budget and Make a Plan

It’s critical to keep your budget top of mind as you’re searching for a home. Danielle Hale, Chief Economist at realtor.com, puts it best, advising that buyers should:

“Get preapproved with where rates are today, but also consider what would happen if rates were to go up, say another quarter of a point, . . . Know what that would do to your monthly costs and how comfortable you are with that, so that if rates do move higher, you already know how you need to adjust in response.”

No matter what, the best strategy is to work with your real estate advisor and a trusted lender to create a plan that takes fluctuating mortgage rates into consideration. Together, we can look at your budget based on where rates are today and craft a strategy so you’re ready to adjust as rates change.

Bottom Line: Interest Rates Aren’t Everything,

Hear me say this: Even small increases in mortgage rates can impact your purchasing power. But, interest rates aren’t everything! It’s most important that you date the rate and marry the home. If you’re in the process of buying a home, it’s more important than ever to have a strong plan. Let’s connect so you have a trusted real estate advisor and a lender on your side who can help you strategize to achieve your dream of homeownership this season!