How Does the Mortgage Rate Affect Buyers?
Mortgage rates are one of the most important factors prospective homebuyers should consider when buying a new home. Even a small fractional move can have major consequences in deciding which homes you can afford.
In addition to lowering the amount of money you need to borrow from your bank for your new home, lower interest rates give a boost to your buying power, since a smaller portion of your monthly payment will be put toward interest. This translates to the ability to afford a little more house than you might in a higher rate environment. Let’s illustrate and clarify this with an example:
Let’s imagine that when Susan bought her house, she paid the market price of $250,000. She made a common down payment of 10% ($25,000), financing the remaining $225,000 at an interest rate of 6%. She would have to pay $1,349 each month to meet the mortgage payment. She would pay $260,363 in interest alone If she kept her house for the entire duration of the standard 30-year mortgage – surprised by these very major interest payments?
But Susan decided to sell her house after several years. Because home values increased in the interim, her buyer, John, will purchase the home for $300,000. John also decides to put down 10% ($30,000) at the closing, leaving him with a mortgage of $270,000. But interest rates had fallen, and John gets a rate of 4%.
Despite paying more for the house than Susan, John’s monthly mortgage payment would be $1,289 (compared to Susan’s monthly payment of $1,349), and he’ll only pay $194,048 (compared to Susan’s $260,363 over the life of the loan), due to the lower interest rate.
As you can see, interest rates are of monumental importance to a homebuyer.
Redfin (a Seattle based real estate brokerage and listing service) conducted a study to illustrate the difference a buyer would pay monthly to a lender between a mortgage rate of 3.25% and 2.75%.
At a 3.25% interest (in a typical 30-year fixed mortgage), an imaginary homebuyer can afford a $506,000 home, and make a monthly payment to the lender of $2,500. If, however, the interest rate was 2.75%, the same buyer would be able to afford a home of $529,250 on the same exact budget according to the study.
According to the study, a homebuyer would lose $23,250 in spending power, representing the difference in the above mortgage interest rates.
The study included four Florida cities which were not much difference than national numbers above.
Based on the same $2,500 budget for the mortgage:
In Jacksonville, 83.7% of homes were affordable if interest rates are 2.75%, but that falls to 82.7% of homes if rates are at 3.25% (a 1% drop).
In Miami, 61.3% of homes are affordable at 2.75%. That number drops to 59.5% of homes if rates were at 3.25% a (a 1.7% drop).
In Orlando, our buyer can afford 83% of homes at 2.75%, but just 81.6% at 3.25% (a 1.3% drop).
In Tampa, 81.4% of homes are affordable at 2.75%, but just 80.2% at 3.25% (a 1.1% drop).
Nationally, 68% of homes were affordable with the same $2,500 a month budget with a 3.25% interest rate. That number rises to 70.1% of homes if the interest rate was 2.75%.
Interest rates have risen lately. In January 2021, a 30-year fixed mortgage rate averaged just 2.65%. Today the average rate is 3.24%.
Redfin’s chief economist, Daryl Fairweather, said, “If the 1.9 trillion stimulus package that’s set to provide cash relief to Americans and get people back to work is successful, interest rates are likely to inch back to pre-pandemic levels of about 3.5% …”
Typically, as the economy gets stronger, interest rates tend to rise along with economic growth.
Finally, although mortgage rates rose about half a percent between January and March, they are still very low by historical standards. Click here to see an easy-to-read chart of historic interest rates. You will see that interest rates are still extremely low today compared to any point in the last 50 years.
Due to these low rates, buying in the near term could save a small fortune in interest payments.