Home Real Estate How Lower Mortgage Rates Affect Your Buying Power?

How Lower Mortgage Rates Affect Your Buying Power?

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Lower Mortgage Rates

Lower mortgage rates

Owning a house is a dream of every American or everyone in this world. In fact, it is a basic right of every human being to have an owned place to live. Some of us are blessed with this “gift,” while some are not. Buying a house is a “healthy” activity for your finances, and not everyone can afford to buy a house with a “lump sum” amount. Of course, you can opt for a “fixed-rate mortgage” option. This allows you to settle your loan in installments, and the burden of paying “all at once” can be reduced. In this article, we will look at effects of lower mortgage rates.

Mortgage rates play a significant role in this process, and an increase or decrease in mortgage rates can affect your buying power significantly. You can evaluate the importance of change in a mortgage rate with this common quotation, “even a change of 0.125% in mortgage rate, the home buying power can increase or decrease significantly”.

Higher and Lower Mortgage Rates

An incline in the mortgage rate can reduce your buying power, while lower mortgage rates can boost up your buying power. Mortgage rates not only affect the amount of interest rate you will pay during the life span of the loan, but it also has a huge impact on your “buying power” as well. In simpler words, you are most likely to buy a “less-home” with your money if the mortgage rates increase and vice versa.

Current market situation

September 2019 saw the lowest fixed mortgage rate of 3.5% as far as a “30-year” category is concerned, and now it has increased slightly with 3.7% as the average for the past few months. This means that buyers had the potential to buy more expensive and luxurious homes in September at the same price as compared to the mortgage rate now.

Now, for example, if you wanted to buy a home in September with the given rate, you could buy a house costing 400,000 USD or even more with just 1500 USD as a monthly installment. (Note: Keep in mind that insurance, taxes, and other requisites are not included for the sake of understanding). But, let us suppose that the mortgage rate has climbed to 4.6 percent. Now, with the current mortgage rate and keeping the installment amount the same (1500 USD), you can buy a home round about 375,000 USD. 400,000 and 375,000 are very different figures, and the difference is 25000 USD just because of a 1.1% change in the mortgage rate.

Let us discuss some conventional and reliable narratives related to the effects of an increase or decrease in mortgage rates on the buying power:

Your buying power can decrease by 11 percent, with an increase of 1 percent in mortgage rates.

Now, this might sound astonishing, but a small change in the mortgage rate can change your buying power significantly. Let us have a look at this example:

Note: In this example or coming examples, insurances, taxes, property taxes, or HOA charges are not included*

Let’s say; you can spend 1200 USD (principal and interest amount) per month as an installment for your home. Now, if the mortgage rates are low, this amount can go a long way. If you choose a “30-years fixed” contract at the rate of 4.5 percent with 20 percent as a down payment, you can buy a 295,000 USD house with this setup.

What happens with an increase in the rate?

However, if this rate goes to 5.5 percent, and we keep the down payment the same as 20 percent, you will be able to buy a house having a price of 265,000 USD or less. It is evident that your buying power has decreased by 10.17 percent by increasing 1 percent in the mortgage rate. There has been a reduction of straight 30,000 USD from your capacity to buy a house.

-Increasing the amount of installment

Let’s increase the amount of monthly installment and see how much variation a change in rate of mortgage brings. If the monthly installment is 1800 USD and the down payment is the same with a mortgage rate of 4.5 percent. With this setup, you can buy a house with a price of 445,000 USD. But if that rate goes to 5.5 percent and other elements remain the same, then you will be able to buy a house worth 395,000 USD. Your buying power has been reduced by 11.24 percent, and your maximum purchase price has been reduced by 50,000 USD.

Decreasing the amount of installment

Let us discuss the third scenario related to the increase in mortgage rates. This time, the amount of the installment will reduces. Assuming that a buyer is opting for a 1000 USD installment per month and the same 30-years fixed-rate plan and the rate is 5 percent. In this case, a buyer can buy a house worth 235,000 USD, but if that rate is moved to 6 percent, then the buyer’s buying power will drop by 11.49 percent approximately, and the buying power will reduce to 208,000 USD.

Findings

Three scenarios were discussed related to an increase in the rates. It is obvious from these examples that as the purchase prices move in an upward direction, the amount of money shaved off purchasing price due to the increase in the rate is significantly high and vice versa.

In the example where monthly installment was 1800 USD, the rate was 5 percent. The initial purchase price was 420,000 USD, and with an increase of 1 percent in the rate. So, that figure dropped to 375,000 USD. There was a total reduction of 45,000 USD. This figure was lower when the monthly installment was lower. If this monthly installment is raises to 2000 USD and other figures remain constant. Then an increase of 1 percent in the rate will reduce your purchase price by 50,000 USD. This can significantly reduce your chances of buying a house in a “desirable” neighborhood or expensive areas.

Difference between an increase in house prices and an increase in rates

One of the most common misconceptions is that people put more focus. On house prices as compared to the mortgage rates. They believe that an increase in house prices is a more unfavorable situation as compared to the increase in rates. But, the reality is completely opposite. Let us explain this with the previous example where the installment amount was 1800 USD per month. The initial purchasing price was 420,000 USD.

Lower Mortgage Rates how do lower mortgage rates affect your buying power? How Lower Mortgage Rates Affect Your Buying Power? Lower Mortgage Rates

But an increase of only 1 percent in interest rates reduced that buying power to 375,000 USD. This means the resulting figure is a reduction of 45,000 USD in buying power. In terms of percentage, that reduction in buying power was approximately 11.24 percent. And how many times have you seen the house prices increased by 11 percent in a month or even a year? Honestly, never or very rare, to say the least. Therefore, variations in mortgage rates play a significant role in your buying power.

What are your options if the rates go up?

Well, the best option is to buy a house when the rates are down or decreasing. But, if that is not the case, then there are other options. For the potential buyers that can bring an expensive house in their reach. Here is how you can reduce the effects of higher mortgage rates

  • A large down payment (maybe 30-40%) will definitely help to reduce the mortgage rate effect.
  • Inclusion of a “non-occupant co-borrower” option in the loan agreement.
  • Adjustable rate mortgage, also known as ARM, can be opted for buying. In ARM, interest rates are lesser in the initial five years or seven years in other cases. It is up to you whether you choose a 5-year ARM option or a 7-year ARM option.
  • Another option can be used for this purpose, and that is “80-10-10 piggyback mortgage”.

When should you buy it?

There are no simpler words to say. That you are more likely to get a “less home” if the rates go up. It is highly likely that an “11 percent” variation in your buying power can add or reduce. An “extra bedroom” in your “potential house.” Or you may have to shift from a new house to an “older house.”

The rule is clear if the rates are low, that is your best chance. To buy a house of your liking. Of course, your financial or economic stability matters a lot in this matter. But, if you are in a situation where you can buy a house, and the rates look good. And you are still waiting for a “better” chance. Then, it is highly recommended that you rearrange your priorities. Because waiting for further reduction in the rates may actually end up in incline in the rates.

Moreover, it may not be a good idea to keep evaluating the past trends. Related to the increase or decrease in the rates. Because they may not be depicting the exact or accurate information. An increase or decrease in mortgage rates depends on certain factors. Such as demand and supply, economic conditions, feds cuts, etc. Besides, the rates have touched 4.69 percent (high) and 3.65 percent (low) since 2010. But one thing for sure, “very low mortgage rates are a rarity.”

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