How does a one percent increase in interest rate affect housing affordability? Will home prices come down soon, at least enough to offset an interest rate increase? Would saving up for a larger down payment make a big difference in the monthly payment?
These are all worth answering, but before you freak out and do an “OMG!!!” let’s take a look at the numbers…by the way, that’s what we’re here for…to help you to not freak out. Our business cards say “Realtor”, but all too often we find ourselves being counselors…guides…guardrails…protectors…man
How Do Interest Rates Affect Monthly Payments?
If the interest rate bumps up by half of a percentage point, how much does the monthly payment for a 30-year mortgage increase? It all depends on the amount of the loan.
As you can see, when interest rates rise from 4.5 to 5.0 percent the monthly mortgage payment rises by $72 for a $240,000 mortgage and by $209 for a $700,000 mortgage. This works out to an increase of around 6 percent for each loan payment.
How Do Interest Rates Affect Purchase Price?
Most home buyers have a set amount available for mortgage payments. How does a shift in interest rates affect the total loan amount that a buyer qualifies for? Let’s look at two situations:
1. A home buyer with $1,500 a month to spend, expecting to purchase a home with taxes and insurance of $2,500 and $700 a year, respectively.
2. A home buyer with $4,000 a month to spend, expecting to purchase a home with taxes and insurance of $6,000 and $1,500 a year, respectively.
(To keep things simple let’s assume a zero down payment, which means the loan amount is the same as the purchase price.)
In this scenario, when interest rates move from 4.5 to 5.5 percent the loan amount that the buyers qualify for drops by around 10.7 percent.
How Much Difference Does $10,000 Make?
Is it worth saving up an additional $10,000 to put towards a down payment, or waiting out the market in the hopes that the price of a desired home will drop by about that much?
The answer depends on what interest rates do during that time. Here’s an estimate of how monthly payments are affected by a $10,000 decrease in the principal loan amount:
At the 4.5 percent interest rate point, lowering the principal loan amount by $10,000 decreases the monthly payment by $51.
If rates rise from 4.5 percent to 4.875 percent, however, the monthly payment for a loan amount of $240,000 rises from around $1,216 to $1,270. This increase of $54 effectively cancels out the decrease in monthly payment brought about by lowering the loan principal.
Putting It All In Perspective
We’ve become so accustomed to extremely low interest rates that watching them move back into the high 4-percent range is causing some raised eyebrows. It’s worth remembering that as recently as 2004 people were falling over themselves to purchase homes and refinance mortgages at 5.5 percent.
(It’s hard to imagine what it was like for home buyers in 1982, when mortgage rates topped out at over 18 percent!)
No one can say for sure where interest rates are headed, but the general consensus is that they are likely to rise over the coming years. This will inevitably put some downward pressure on the housing market. Even though home prices are generally expected to stay strong, the rate of price appreciation is expected to slow down, and higher interest rates may help areas with severe inventory shortages to regain some balance.