Here’s why interest rates play a big part in your purchasing power.
I’m sure you’ve heard all the chatter lately about low interest rates. The truth is, they’ve been very low ever since COVID hit. In any case, this brings to mind an important question for homebuyers: How big of a deal is it if interest rates drop a full percentage point? To answer that, let’s look at the numbers.
Keep in mind, the following examples represent principal and interest payments only. They don’t include taxes and insurance, so don’t take them as gospel when you meet with your lender.
Now, let’s say your mortgage budget is $1,500 per month. If you buy a home at that budget at a 3% interest rate, you can take out a loan of roughly $355,000. If rates climb to 4% for that same payment, you can only take out a loan of roughly $314,000. If rates climb further to 5% (which is where they were only a couple of years ago), your loan maximum would drop to $279,000. If that’s not a big enough difference, some buyers are getting rates as low as 2.75%. If you can secure a loan at that rate, your borrowing power would jump to $367,000. Between 5% and 2.75%, there’s almost $100,000 worth of difference.
If you can’t afford $1,500 per month and your budget only extends to, say, $1,300 per month, here’s how the scale changes:
- 3%: $237,000
- 4%: $209,000
- 5%: $186,000
Last year at this time, rates were pretty close to 4%, so if rates are 3% or 2.75% now, you can borrow anywhere from $237,000 to $245,000. The bottom line is that from a budget standpoint, the lower rates are, the more house you can afford. Part of the reason we’re seeing home prices increase is that buyers’ purchasing power is increasing.
So yes, interest rates do matter. You can afford more of a home now than you could last year specifically because rates are lower. If you wait a year to buy and rates increase, you’ll be able to borrow less money each month. That being said, economists predict that rates will stay low for a long time, and if they drop even further, I believe we’ll see prices rise concurrently.
As always, if you have questions about this or any real estate topic, don’t hesitate to reach out to me. I’d love to help you.