Let me start out by saying I’m not a lender so the ins and outs of home loans is not my specialty. When it comes to mortgages, I have trusted professionals who help my clients. That being said, I do know one thing about home loans that never changes, interest rates. The thing about interest rates that never changes is that they are always changing. The rate today will in all likelihood not be the rate a year from now. These seemingly small shifts in interest rates have a butterfly affect on how much home you can afford. Let me explain. Let’s say you decide it’s time to buy. You call up your trusted lender and they says, “good news, based on your financial health you are approved up to $100,000.” Now when you get this approval what you’re really getting qualified for is a monthly payment amount. Specifically, how much you can afford to spend each month on your house payment. For the sake of simplicity we will assume monthly house payments are comprised of principle (P) and interest (I). So in keeping with our example, you just got approved for a $100,000 home loan and interest rates are at 5%. You’re monthly payment (P+I) would be $537 a month. Of that first $537 home payment, $417 would be your interest payment and the balance would go to principle. So what if interest rates went up to 5.5%. Remember you are approved for a monthly payment which corresponds to a total loan amount. If interest rats are 5.5% the maximum loan you could get to maintain your $537 payment would be $94,500. With the 0.5% increase in interest rate your purchasing power just went from a $100,000 house to a $94,500 house. So what if interest rates go up to 6%. In order to maintain you $537 payment your loan would be for $89,500. Your purchasing power just dropped from $100,000 to $89,500. In the beginning I told you what I didn’t do, make loans, what I do is sell houses. Let me tell you there is a big difference between and $89,500 house and a $100,000 house.
Here is a pretty good rule of thumb. Every 0.5% increase in the interest rate reduces your purchasing power by $5000. I hope this gives you a better understanding of the way increasing interest rates can cripple your home buying power. If you’d like more details on this topic give me a call.