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How Do Rising Interest Rates Affect Affordability?

I have long been irked by mortgage “pre-approvals” that say a borrower is qualified to purchase a non-specific home for a specific loan amount.  Why?  Because, lenders don’t qualify borrowers based on the Purchase Price of a home, we qualify them for a particular Mortgage Payment (and payments vary based on a number of factors besides interest rates- like real estate taxes and insurances).

You see, lenders know that the price of a home is secondary to the monthly carrying costs of a home because a person’s ability to repay the mortgage is based on their monthly cash flow.  We analyze the new debt (their proposed Principal & Interest, Taxes and Insurances) in relation to the borrower’s income and their other expenses.

Fortunately, most home buyers look at it the same way….”What can I actually afford to pay monthly?”  and  “How will buying this home affect my lifestyle?” are typical questions they ask themselves.  In a rising interest rate environment (like we see now in front of us), those questions can have a significant impact on the market.

Let’s say we have a couple making $10,000 a month.  Let’s also say, they are comfortable paying (and qualify for) a mortgage payment of $3500.  From that $3500 payment, we would deduct an estimated $750/mo. for real estate taxes, $100/mo. for homeowners’ insurance, and approximately $200/mo. for mortgage insurance (assuming an FHA loan).  That would leave approximately $2450/mo. for Principal & Interest.

At 5% mortgage rates, our hypothetical borrowers would qualify for (and be comfortable paying) a $446,000 base loan amount.  At 6%, the same total mortgage payment of $3500 can only give our borrowers a base loan amount of $399,000!!!  A 1% increase in rates, can reduce buying power 10%!!!

What are the implications and possible outcomes of this mathematical certainty?

1- Buyers may wind up with a higher mortgage payment than they are comfortable with and their lifestyles will suffer (in our example, the payment would escalate $280/mo.)…..or worse, they may no longer qualify for their loan and deals could collapse.

2- Buyers will have to “lower their sights” on lesser homes in lesser neighborhoods because their monthly carrying costs are the true determinant to buying a home.

3- Buyers may choose to “wait it out”, hoping that rates will come back down (much in the same way sellers held on to the belief that prices would rebound).  There is no logic behind that hope, but that won’t stop buyers from getting on the sidelines.

4- Sellers will have to reduce home prices another 10% to attract buyers back….that way the buyer can get the payment they need to buy.

5- Buyers AND Sellers can kick themselves, whine and moan, and feel victimized by circumstances.

Forget about looking backwards.  To do what’s best for your family, know these two things:

1- For Sellers, TODAY is the PEAK of YOUR MARKET.  You are not likely to get the price you could get today for years to come.

2- For Buyers, TODAY may be the lowest interest rate you will be able to get for the REST OF YOUR LIFETIME.

Remember, Buyers and Lenders want the same thing….an affordable payment.  The price of the home is secondary to the monthly cost of the home.  ACT QUICKLY, if you are looking to buy to get the home you want, in the neighborhood you want, for a payment you want.  PRICE AGGRESSIVELY, if you don’t want to miss out on the opportunity to have as many qualified purchasers to be able to afford to buy your home.  TIME IS NOT ON YOUR SIDE.

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