There was some significantly impactful news for homebuyers this last week. The benchmark interest rate from the Federal Reserve will remain unchanged for the foreseeable future. While this rate isn’t directly tied into mortgage rates, it does have a significant impact. It is no secret that mortgage rates have slowly crept higher over the last twelve months. This has reduced the number of new home purchases and slowed the once red-hot real estate market. By the Fed not changing their benchmark rate, mortgage interest rates crept lower and should remain that way for the foreseeable future. It should not be understated just how big this is for potential homebuyers. Here are four areas where the impact of lower interest rates will be felt.
Decreased Payment. You don’t need to be a finance major to know that lower interest rates decrease your monthly payment. The principal and interest portion of your payment is directly tied to the simple interest rate of your mortgage. Don’t be fooled by the APR or any other number. The higher the loan amount, the less the rate must move to have an impact. A $500,000 loan with a rate of 5.5% has a principal and interest payment of $2838 per month. The same loan with a rate of 5% has a payment of $2684, which equates to a savings of $154 a month. This reduction could help get you under a key number for loan approval or at a minimum make you more comfortable with the monthly payment.
Higher Pre-Approval Range. There are three key factors that determine loan approval: credit score, down payment and something called debt to income ratio. With this the lender adds up all the minimum monthly payments on the credit report in addition to the proposed monthly payment. They then divide this number by the gross monthly income. If that number is over 50% the loan will not be approved. With lower rates the monthly payment is lower, giving you a much better chance of loan approval.
More House. Most buyers try to balance affordability with livability. Everyone would rather live in a bigger home if everything else was equal. Lower interest rates allow you, the buyer, to keep the same monthly payment while getting more home. On the example used above a buyer may have a maximum number of $2700 for their principal and interest payment. When interest rates rise, they shoot over this and are forced to lower their purchase price range. Either that or they consider stretching their budget and going for the property anyway. Neither of these is a welcome option for a homebuyer.
Lower Term. One of the goals for homeowners is to pay their home off as quickly as possible. They can do this either buy putting more money down or adding extra principal payments from time to time. Another way of doing this is by taking a shorter mortgage term. With lower interest rates you can consider a shorter term without your monthly payment skyrocketing. It will certainly go up based on the term, but with a lower rate it may be something that doesn’t break the bank.
There is no question that lower interest rates are a major benefit to buyers. Ask any homeowner who looked at houses when rates where in the 7’s and 8’s if they would take 5%. Even though rates should remain low for the coming months, there is no guarantee things will stay the same. If you are considering buying a home, you should explore your prequalification options and start looking before things change.