How Mortgage Rates Affect What Home You Can Afford
Mortgage rates are incredibly low at the moment, but that won't last forever. And higher interest rates could put your dream home out of reach.
Owning a home is a huge part of the traditional American dream. Buying a home has become easier recently, thanks to almost record-low interest rates on 30-year fixed mortgages. If you’re thinking of buying a home in the next few years, you’ve probably looked up home prices so that you can start saving up money for a down payment and closing costs. Unfortunately, one factor could make your dream home unaffordable if you wait too long to buy: mortgage rates.
Figuring Out How Much You Can Afford
When my wife and I were considering buying a home, we opened up a mortgage payment calculator. We plugged in the purchase price, down payment, and interest rate to see what payment popped up. From that, we determined whether we could afford the mortgage. We played with the numbers a bit to see what we could comfortably afford.
In the end, we were pleasantly surprised by how much house we could afford in the low-interest-rate environment. Unfortunately, interest rates haven’t always been this low, and they may start rising soon.
If interest rates increase, your buying power will go down – and it might go down a lot more than you’d think.
Here are a few examples with our last home purchase:
A Real-Life Mortgage Example
This discussion is only on the principal and interest part of your mortgage payment. You’ll have to add insurance and taxes to calculate your total mortgage payment and make a complete decision about your finances.
My wife and I bought our second house in 2013, when interest rates were similar to what they are today. We were still paying off my wife’s student loan debt, so it was important to keep our mortgage payment below $750 per month. We ended up securing a $150,000, 30-year mortgage at an interest rate of just 3.5 percent.
The payment was only $674 per month, and we were ecstatic.
We wouldn’t have been so lucky had we been shopping for a home loan just 10 years earlier. Interest rates were hovering around six percent at the time, which would have put that same mortgage at $899 per month. We wouldn’t be able to buy the home we wanted because it would have been unaffordable to us. The 2.5 percent higher interest rate at that time would have added $225 extra to our payment schedule. That’s almost a 33 percent increase. In fact, if we wanted to stick to our $750-per-month maximum payment, we could only have taken out a mortgage for roughly $125,000. And if we wanted to stick to the $674 mortgage payment we ended up getting, we could only have taken out a mortgage for roughly $112,400.
To give you an idea of the worst-case scenario, mortgage rates were 18.45 percent in October 1981, according to Freddie Mac. My $150,000, 30-year mortgage would have had a monthly payment of $1,931. We definitely wouldn’t have bought our home back then!
What Should You Do With This Information?
Many people will look at rising interest rates and decide to rush into buying a home. I don’t think anyone should ever do that. Yes, lower interest rates result in lower mortgage payments. But if you rush into buying a home, you might end up in financial trouble.
Interest rates may not increase for years to come. Back in 2013, when I bought a home, everyone said that interest rates would go up significantly in the coming years. But here we are in 2017 with near record-low interest rates again.
If you want to speed up your home-buying timeline, don’t skimp on your down payment. And keep plenty of money in reserve for an emergency fund. Instead, kick your savings into high gear by earning extra money at work, doing a side hustle, or picking up a part-time job. We did exactly that back in 2013. In fact, my side hustle was so successful that it turned into my full-time career.