How Mortgage Rates Affect Purchasing Power
Do you want to buy a home in Chesapeake, Virginia Beach or Moyock but are wondering how the rise of interest rates will affect your home buying power?
The Fed raised rates by another 50-basis-points in December to 425 basis points this year, but target range for 2023 is still 85 basis points higher. With the rate starting this year at zero and now at its highest point since late 2007, homebuyers have reason to wonder how this will affect them.
In a normal market, the increase of interest rates would directly correlate with the decline of home prices in order to balance out affordability for homebuyers. However, we are not in a normal market this year. We have seen the rate of growth slowing, but home prices are still at record highs.
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Understanding Homebuyer Purchasing Power
When purchasing a house, the most important consideration isn’t the overall price of the home but the home’s total monthly cost, including the mortgage payment, property taxes, and the cost of homeowners insurance. As you budget for a home, the total amount is critical and will ultimately determine the amount you can borrow. One of the most important factors that determine the amount you can borrow is the interest rate.
How Do Interest Rates Affect Purchasing Power?
In a fixed-rate loan, the interest portion of the loan is amortized over the life of the loan, meaning each payment is the same amount. Therefore, a higher interest payment means that the borrower will have a higher monthly payment over the entire life of the loan.
The smallest changes to interest rate can have a large impact on the total amount a borrower can qualify for. For each 1% increase in interest rates, the total amount a borrower could qualify declines about 10%.
Let’s explore a scenario. Say that you are approved to buy a home with $1,500 budgeted for principal and interest, excluding property taxes, insurance and other cost. At a rate of 3% interest for the beginning of the year, a borrower could expect to be able to buy a house around $355,000 with a 30-year fixed rate loan. Rates have increased significantly this year and are now sitting at around 7%. The same budget of $1,500 for Principal and interest with a 30-year fixed rate loan at a 7% interest rate would bring the home price down to $225,000. That is nearly a 40% decrease in purchasing power. Feel free to complete your own mortgage calculation here.
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