Rising Mortgage Interest Rates: Good or Bad For Potential Home Buyers?

The hot real estate news this week is that interest rates on mortgage loans rose abruptly, thanks to some international happenings influencing Treasury rates here. According to this NY Times article, the national average for the 30-year fixed-rate mortgage jumped to 6.74 percent yesterday. At the beginning of the year, the average was only 6.18 percent.

As a potential homebuyer, my question is, will this be make homes more or less affordable? On one hand, rising interest rates will mean a bigger monthly payments for the same loan amount. But on the other, such higher payments may also start pushing home prices downwards. I’m sure the answer to this question is extremely complex, but I started to run some simple scenarios anyways.

Effect of Interest Rates on Monthly Payments
Here what happens when the rates change on a $300,000 loan:

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As a rough estimate, when the interest rates rise by 1%, the mortgage payment rises by 11%. (Used the calculators at Dinkytown.)

Effect of Interest Rates on Affordability
For better or worse, lenders determine how much house you can afford by figuring out a maximum monthly payment based on your income. (I’ve written before about how these lending ratios can vary.) So if you keep the same maximum payment and the rates rise, then you can only afford a smaller loan amount. Here are some numbers starting with the previous example of a $300,000 loan.

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So? Good or Bad?
I’m just using loan balances here, so I’m ignoring the dampening effect of house downpayments. And again, actual housing prices don’t fluctuate according to such simple rules. Maybe housing prices won’t drop enough to counter the higher payments from future interest rate hikes.

Still, one thing is for sure – people who have been shopping for homes may not be able to afford what they thought they could or maybe even were already pre-approved for. Rising interest rates can also affect the housing market in other indirect ways. For example, when people with adjustable-rate mortgage try to refinance to a lower fixed rate, they’ll either be rejected or still be faced with a much bigger mortgage payment. This may lead to more foreclosures and lower prices. At least I selfishly hope so…

Comments

  1. I ultimately think it will push market prices down, which is a good thing. It’s a bad time to buy a house! After the recessions and the large decrease in interest rates, I would see one 4500 sq. ft. go up right after the other. Guess who was living in them? Families with incomes ranging from 75k-150k. They over extended themselves because their monthly payments are so low resulting from the low interest rate.

    Is this a good thing or bad thing? I’d say it’s bad when you realize you can’t afford to heat it, pay taxes on it, or even fill the thing with decent furniture. When you go to sell it, nobody could afford it. Huge losses by you and also to the banks from foreclosures, etc.

    Let’s hope this brings market prices back to “normal”.

  2. Seems most economists these days think interest rates will top out around 7% by the end of the year. That would still be pretty low by historical standards. My parents took out a $300,000 mortgage loan back in the 80s at something like 14% interest!

  3. I think it will be at least 30-60 days before we see any fallout from the recent rate increases. People preparing to buy a house in the next month or two will already have a ‘locked in’ rate from their mortgage. If the rate bump is short lived, then the effect won’t be very significant, given that people will just ‘bump down’ their rates if they drop before closing.

  4. Holy cow, I just used the calculator on dinkytown, and a $300k loan at 14% would be $3550/mo!

  5. I just signed a contract for a new construction home so I still have like 5 months to really finalize my mortgage. I just hope the rates go down, or at least start their downward move. But right now the predictions are the other way. Fortunately, I did keep a buffer of a 100 dollars in my monthly payments.

  6. It seems that home values have inflated so high in the last 7 years, that the higher mortgage rates are going to compound a problem that we are beginning to see: Even as real wages for middle and low income families has held stagnant, homes have appreciated to the point where they are completely unaffordable to the average family.

    All this probably means that it is a great time to own properties that you rent out: as the rental market should surge, due to the affordability problem of owning.

  7. My belief that the best time to buy real estate is when interest rates are at their peak. Theoretically this should be when prices are at their lowest. Your monthly payment will be roughly the same initially (lower price + higher interest rate = same monthly payment). You’ll get the best possible price, then when interest rates fall, you’ll be able to refi into lower rate. Given a timeframe of 5 or more years you’ll potentially be able to have both low rates and low prices.

  8. Higher interest rates are best for people who (obviously) have their money in the bank. But the best thing about prices going down is that improved properties are also going down. This is where you can really save money. If you are going to buy anyway — get the home that is all fixed up. Not only is it easier in general — but you won’t spend tomorrow’s prices (besides your labor if you do it yourself) on building materials. My husband noticed recently when he put in new heating upstairs that copper (pipe) has TRIPLED in price in 7 years! So all the improvements that were done prior were much less expensive. I would think contractors are charging far more now than before in order to turn a profit.

    Yes, some improvements lose value over time, but especially now — when materials are so expensive, buying a fixed up house is very valuable. Even if they factored in yesterdays’ contractor prices into the purchase price — you will still be getting a bargain.

  9. Ted Valentine says:

    Good analysis. I have long believed the housing price “bubble” (or inflation as I believe it really is) was sparked in the early 2000s by 1) mortgage fixed interest rates bottoming out as low as 4.25 and 2) the tech stock collapse.

    Of course lenders are now reacting to all of the defaults on the high risk variable rate loans they were handing out. I’m still shaking my head at this phenomenon. I can’t decide who’s dumber, the people who absorbed the risk of a variable rate when fixed rates were near record lows or the real estate professionals (lenders and agents) who steered people into these “products” to make more in commissions.

  10. Another thing to take into consideration, although on a smaller scale, as to how valuable it can be to carry an assumable mortgage. Ours is, and locked at 5.5% that alone can be a very appealing selling point. On the other hand, if I do sell in this market I have to consider the costs of the higher rates on the new mortgage.

    On the previous post about the cost of copper rising, part of that is also causing people to break into homes (empty, new construction, and others) to steal the copper piping. A friend had to replace all the copper in a rental property they were selling after thieves broke in and removed 90% if it.

  11. Steve Austin says:

    Good for you as a prospective buyer, as you can use the trend in rates and home prices (depends on the local market, of course) to substantiate the low ball offers you’ll be making. Your hypothetical conversation with the seller (or her broker): “Well, I’m willing to wait it out a year or so if you are, but I’d just as soon like it if you’d meet me half way between then and now and take my reasonable offer.”

  12. Nony-mouse says:

    Buy cash if you can and you can live peacefully. Or have a huge downpayment

  13. I agree with the sentiment that higher interest rates are good for buyers in the long run. If it helps to bring prices down it will make for a saner market.

    Plus I like the idea of being rewarded for saving up a large down payment vs. the no-down impulse buys of the past few years. And you can always refinance to a lower rate, but you can’t re-negotiate the sale price after the deal is done.

  14. Hey Jonathan, you’ve really nailed a good one here. I ran a quick Google and it definitely looks like there is some scholarly material on the subject (but it is “pay-for-play”)

    link

    One of the articles mentions defalationary periods vs inflationary periods, which seems like it would definitely affect house prices. Given that we’re firmly stuck in an inflationary period here in NA, I’d think that your analysis is probably correct.

    And poster Jon, hit the nail on the head with his comment. Peak interest is definitely the time to lock in short term mortgages if you’re planning to sell when interest rates come back down.

    Of course, if you’re planning to keep the house, then the strategy would seem to be the exact opposite. If you can say, “I have this home and I’m going to live here until the end of my mortgage”, then the strategy seems to be taking the lowest interest rate. If you’re not planning on selling the house for 30 years, then the initial price paid for the house is so little compared to the effect of even 1% interest differential.

    Of course, the unsung factor here is elasticity of the markets. As Joe mentions, interest changes won’t affect house prices of those already pre-approved. So there’s bound to be a delay. Plus it’s spring so any downward pull may be countered by spring increases and won’t really be felt until the fall (when interest rates go up again and prices drop). And lastly, people are pretty bad at math, so this whole “rising interest rates” thing will likely be lost on people until it hits some magic number (say 8%).

    Like an elastic band, the prices will stay the same, but the pressure to change those prices will increase. When some big event (like 8%) comes into the public consciousness and makes the front page, then everything will snap into focus and house prices will correct.

    So again, your math is good, but you’re probably at the front of the pack. What you’ve said is correct, but hasn’t been generally realized and it probably won’t be realized until this fall.

  15. I think the rate increase does benefit home buyers with high down payments. This way the increase doesn’t effect them that much, however you truly have the opportunity to build equity because prices should be pushed down even further pretty soon due to this. When interest rates go down in the future you can likely refinance with a zero closing cost loan and decrease the monthly payments.

    However for lower down payment individuals, perhaps a better choice may be to rent and keep saving for a larger down since the monthly payments will put a strangle hold on their ability to stash away savings.

  16. Billy Joe says:

    The time to buy is today- especially for first time buyers, at least in Illinois.
    Why?
    Prices for existing homes are down.
    Interest rates remain affordable.
    Pent up demand for housing, especially in year 2008 will increase – driving the prices for homes upward.
    The market is depressed due in large part of the media.
    In my opinion buy now and save at least $25,000 on homes going for $360,000-$450,000

  17. OK Billy Joe;

    I got to ask you about these first time buyers you’re talking about. B/c you’re telling me that homes in the 360k to 450k are going UP in price!

    The median family income in Illinois for a 4 person family is 72k. Punch in your 360k house into a mortgage calculator at 6.74% over 30 years and this family is paying $2330/month to own that house!

    This family has a monthly pre-tax income of $6000 and likely $4000 or less left after tax. Saving 25k drops that mortgage payment to 2170. How is this a good market for first-time buyers? Even if those buyers have 25k-50k of their own to put down, they’re still spending literally 50% of their after-tax dollars on housing. Add in a car to go with that house and 4 mouths to feed, plus insurance, homeowner’s taxes, utilities, home maintenance and healthcare costs and I don’t see how this family can make ends meet.

    So you may be right about short-term housing prices, but you’re talking about houses that are unrealistic for even the average family. The 25k “discount” is irrelevant b/c you’re talking about houses that outside the universe of all but the top money earners.

  18. Hi Wise Men,

    I am completely new to U.S. and to Real-estates. I came to U.S. last year and am purchasing my new home in Pittsburgh, PA. My home will be built in November 15, 07. I am planning to close on Nov, 25 if everything goes as per plan.

    The Mortgage company (a sister concern of the builder) is giving me a current interest at 6.375 (for 15 year fixed). To lock the interest rate for 165 days (nearly till dec, 10-07); interest rate would be 6.625 (6.375+0.25) and I will need to pay 1% ($2500) upfront which will be returned to me during closing.

    If the interest rates drops between 10-45 days before closing; I have a one time option of locking-down at market rate + 0.25. If the interest rates rise really high; they can increase my rate from 0.25 to 0.5%.

    I am paying 10% down on a 250,000 home. Should I go ahead and lock my interest rate now or wait till October 15-2007?

    Your guidance is much appreciated.

    Regards,
    Roma

  19. I believe that the Fed will lower rates by .25 to .50 after mid October. If you watch the historical nature of interest rates, you will see that most years interest rates go down after the primary home buying season. Another variable to consider is that we are coming up on an election year, this has had an impact over the last 1/2 century as well….but we REALLY never know until after the fact, so roll the dice.

  20. I find all of the comments interesting and very well thought out. I too like to speculate as to how the current issues will play out. I just starting thinking whatever happened to the pure joy of home ownership? Why do we (myself included) watch interest rates and prices like a hawk when we know that long term real estate is a great investment. High interest rates can certainly cause some problems but fortunately we do have tax write offs. I feel like many people buy and sell buy and sell these days. I look at people from a couple of generations back. They struggled to buy their first home, worked hard to pay it off and by retirement (often before) they didn’t have house payments to worry about. They built equity through paying it off and through appreciation. As most people know you are paying mostly interest at the outset of a loan period. If we just keep refinancing and buying/selling in short time spans aren’t we kind of shooting ourselves in the foot here? I am not sure that this view will be well received or that it is really even economically sound in today’s world. It just seems like common sense that perhaps we start looking at a house as a nice long term investment in which we get to live, enjoy our family, write off and get creative with. These are not just investments, they are homes. If we treat them as such they will reward us over time.

  21. OK Jenren, the whole thing we’re talking about here is that homes are NOT “great long-term investments”.

    We’ve talked about this elsewhere, but buying a home is actually both an investment and a mitigation of the cost of putting a “roof over your head”. When people “do really well” on their “home investments” it’s typically b/c they’re bad at math and b/c they didn’t invest any where else.

    At best, a home is lifestyle decision with some investment potential attached to it. If you end up moving before the mortgage is up you can completely tank any “investment gains”. The “investment” itself has a heavy overhead: property taxes, extra insurance costs, utilities, and maintenance. When you choose to buy a home, your monthly expense don’t end with your mortgage, they just start with your mortgage.

    If you like painting your house and you want to keep your kids in the same spot for 25 years, then sure go for it. But today’s market is a global, mobile marketplace. “Investing” in a home reduces your mobility. But mobility is actually a job asset. So if you plan to make big money and follow the action, then “investing” in a house is actually giving yourself a liability.

    A home doesn’t “reward” you, it doesn’t give you anything after you die, it doesn’t magically “pay off” just when you need it, it won’t instantly give you the cash to pay a hospital bill. Owning a home is just one way of mitigating the “I need a roof over my head” cost that is inherent with living. If your lifestyle fits with home ownership, then go for it.

    But please don’t imagine that it’s some form of standardly useful investing decision. Owning a home is a mitigation of a cost. Renting pretty much always mitigates that cost for significantly less. What you’re asking yourself is are you going to make out better saving/spending your extra money or throwing that money at the home.

  22. Hello ~

    My husband and I financed a new construction home back in May ’07. We are first time home buyers and new to this whole process. When we were approved, we understood that our rate was 6.5%, no points (and a VA loan so no PMI.) We were not offered any type of rate-locking program at the time. We felt that we had a good deal. Now our bank is encouraging us to lock a rate, as they are rising. Our bank has a new “Builder Rate Lock” Program. They are offering us 7.25% (7% rate and .25% to lock it.) This is a higher rate and though we could afford it, we don’t like spending the extra cash each month. We do have a one time option to float to a lower rate if one is available before or at 45 days before closing. We would just like some advice as to what we should do. We have to pay about 4500 dollars (refunded at closing) to lock our rate. Should we gamble and wait to see what the rates are around our closing date (Mid November) or should we pay the money to lock our rate now?

  23. Karen J Says says:

    I,ve heard with interst rates going up, it eventually will push sellers to lower the price of their homes inorder to sell. I think alot of people will be surprised, because I believe these sellers for the most part cannot lower their prices because they need to make some type of a profit off their homes inorder to purchase another house. People have over extended themselves and point blank, I think alot of people right now are stuck between a rock and a hard place. I see some home prices falling , but the majority I think cannot. Unfortunately…unless more people start getting more money in their pockets or the mortgage intrest rates drop so low that people can start selling their homes, Ican only see a mexican stand-off between our economy ,banks and homeowners.

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