Since the start of 2018, interest rates have crept up more than a quarter point to the current average of over 5.0%. Historically speaking, this is still a tremendously low level, but compared to where they were just a few years ago it may be a sign of things to come. Mortgage rates have a trickle-down effect on almost every sector of the real estate market, as well as the overall economy. A quarter point hike may not seem like much, but it impacts affordability, mortgage approval and the amount of down payment needed. If you are thinking about buying a house you may want to consider locking in now, before rates get too much higher. Here are four effects of rising interest rates.
Affordability.You don’t have to be a finance professor to know that rising rates impact affordability. Higher rates mean a higher monthly payment and reduced money to spend on other areas of the home. Where rising rates really have an impact is with higher priced homes. A loan amount of $400,000 just a few months ago at 4.5% had a principal and interest payment of $2026. That same loan with a rate of 5% increases the payment to $2147. The higher the loan amount the more drastic the change is. With more buyers watching their bottom line even a slight rate change could impact the maximum purchase price amount.
Loan Approval.Mortgage loan approval is based on three core items: credit score, down payment and something called the debt to income ratio. In simple terms the lender adds the minimum monthly payments on the credit report as well as the proposed monthly payment and divides that number by the monthly gross income. This number needs to be under 50%, with most programs under 45%. With higher rates, the mortgage payment increases and the debt to income ratio rises. This number is firm with lenders meaning even if it is slightly over your loan will be rejected.
Increased Down Payment.One way to keep your debt to income ratio low and your housing payment affordable is to increase your down payment. A reduced down payment is great in theory but may not always be the most practical solution. Many buyers are not willing to empty their accounts for their down payment. This leaves them in a tough spot to either accept a higher monthly payment or look for reduced price homes.
Reduced Demand.As interest rates have risen, mortgage guidelines have largely stayed the same. Rising rates may make buying more difficult, which reduces the overall buyer pool. This can mean fewer houses sold and over time reduced sales amounts. This could further limit the number of houses on the market as sellers will be tempted to keep their properties rather than sell for a number they are not comfortable with.
Interest rates have stayed low for many years, with this year being the first sign of any significant increase. Again, historically speaking a 5% rate is on the low end of the spectrum but compared to where they were a few years ago it is an increase. If you have been on the fence whether to start looking it may be a good idea to get prequalified ASAP. Interest rates will not stay this low forever.