Mortgage interest rates have been at historically low levels for a very long time — longer that almost anyone believed possible. (See Mortgage Interest Rates — Historical Perspective.) Over the past several weeks, rates have been increasing, slowly but fairly steadily, pushing just above 5% last week. You have to go back to the mid-1960s to find sub-6% rates, so it’s not time to panic. Nonetheless, rate increases do increase monthly payments.
Let’s say you plan to purchase a home and have budgeted $1,000 per month for your mortgage payment. (To keep this discussion focused, I’m working with Principal & Interest payments only.) Let’s also assume that you began your home search a few months ago when a strong borrower could qualify for a 4% rate on a 30-year fixed rate mortgage. Unfortunately, your dream house hasn’t appeared yet, and your loan officer now tells you that the same loan will come with a 5% interest rate now. If you’re looking at $200,000 homes, your P&I payment has gone from $955 to almost $1,075 per month. Assuming that doesn’t push your debt-to-income ratios beyond acceptable levels, you have a budget decision to make: where to you find that $120 per month?
Assume your budget can absorb that change, how much more will it take? You may be surprised at the impact of interest rate increases on your planned house payment:
Click to enlarge that chart and you’ll see that if you plan a $200,000 home purchase using a minimum down payment FHA loan, the difference in your monthly P&I payment between 4% and 7% is $375. Some folks can skip the morning latte and a couple of dinner-and-a-movie nights and still buy the house they love fairly comfortably.
That change will force many home buyers to downsize their dreams, either to keep the family budget intact, or just to qualify for a mortgage loan. How much? If you were approved for a $200,000 purchase at an interest rate of 4%, here is what that same payment will buy as rates increase:
That’s right, if you delay until rates hit 7%, unless you change your budget or qualify for a larger payment, the price of your dream home must change to less than $145,000 instead of the $200,000 you had in mind originally!
I haven’t seen a forecast yet that we’ll see 7% interest rates this year, but we are not likely to see 4% again either. The point of this post is that there is a real cost in delaying during the market recovery that is beginning to take shape — faster in Austin and Central Texas than in most areas. Will higher rates force home prices down? Possibly, but even if they are willing, many sellers won’t be financially able to reduce their prices. I expect to see market forces work to hold home values relatively stable in Central Texas, and if so the change in buying power described above will be close to reality.
The difference between 5% and 6% mortage rates is about $125/month, or almost $20,000 in purchasing power. Choosing a home is important, but don’t delay unnecessarily. This change in the market looks like it is gaining a foothold.