Mortgage interest rates and monthly payments

Earlier today I wrote a short post about my thoughts on the loud, and so far lose-lose, debate about the U.S. debt ceiling.  The problem is the debt, not the country’s credit limit, and the surest sign that you have borrowed too much money is when you have to borrow more to keep making your payments.  There isn’t a happy ending to that story, so I’m ready for the real debate to move forward.

The point of that earlier post, however, was that I don’t see any reason that failing to raise the debt ceiling next week will immediately trigger an unbearable increase in interest rates.  Short term bonds may call for a higher yield, but since this is a real estate blog I focus on mortgage interest rates, which tend to track the 10-year T-bill more closely than a 90- or 180-day investment.  Unless you believe that our government will never deal with the debt or the debt ceiling, then the risk-reward equation for 10-year bonds shouldn’t change next Tuesday.

With that said, it is a fact that mortgage rates have been held artificially low for years now, and they will go up in the future.  I have stopped trying to predict when that will happen on a continuing basis, so what we have seen over the past year or so is probably a decent indication of what we’ll see over the next six to twelve months, at least.  That history has seen mortgage rates bounce up 1/8% to 1/4% one week, then back, down 1/8% to 1/4% another week, then back.  We’re balanced around a “par” rate of about 4.5% at this point.

But let’s say the rates bounced “all the way” up to 6%.  What would that mean to the average homebuyer?  To answer that, consider buying a $200,000 home (near the median in Austin), with a 3.5% down payment on a 30-year fixed rate FHA loan.  Here’s what happens to the monthly payment (principal and interest only) as rates go up:

A change in monthly payment of $179 is probably significant for many buyers in this price range, so rising interest rates will effectively reduce the buying power of those buyers.  On the other hand, we have seen MUCH, MUCH higher mortgage interest rates and the world kept turning, homes kept selling, and life went on.  See Mortgage Interest Rates — Historical Perspective and you may feel better about what’s going on now.

I don’t expect mortgage rates to move much outside the range we have seen over the past year until there is a stronger, more predictable recovery underway from the current recession.  Will an increase from 4.5% to 5% discourage or disqualify some prospective homebuyers?  Possibly.  But for most of us $50 or $60 per month wouldn’t really challenge our way of life.  Each of us must make that decision for ourselves, but I don’t see mortgage rates at 5.5% or 6% as a “sky is falling” scenario for the real estate business or our national economy.