What do higher interest rates mean for home buyers?

According to the National Association of Realtors [1], about 87% of home buyers use some sort of financing to purchase a new home. On average, they finance about 88% of the value of their home purchase (even more for first-time home buyers).

These statistics mean that the purchasing power these home buyers have – measured by the mortgage interest rate – makes a big difference.

As of this writing, the Federal Home Loan Mortgage Corporation (FHLMC, known as “Freddie Mac”) reports [2] that the national average for a 30-year fixed rate mortgage (with 0.6 points) is at about 3.0%. This is up slightly from the 2.66% rate measured at the end of 2021, which was the lowest since the organization began reporting in 1971.

To put these rates into historical context, the highest rates observed by Freddie Mac were reported in October 1981, at about 18.63% (with 2.2 points). For the most part, mortgage rates have been at or below five percent for about the past decade.

Why does this matter? It matters because changes in the interest rate can make home buying more or less expensive. Take the following example.

The Massachusetts Association of Realtors reported that the median sales price of a single-family home in Massachusetts was $529,000 in April 2021 (a record high) [3]. At a current interest rate of 3.0% and assuming a 20% down payment, the monthly payment on this loan (with no points or PMI, and not including escrows for taxes or insurance, etc.) would be $1,784.23.

If the interest rate were to increase to 4.0% — a big increase, but still a relatively low rate historically-speaking — the payment would increase $236.19 per month for the same loan. This presents the home buyer with one of two choices: pay more or get less.

If the buyer doesn’t change their buying habits at all and just purchases the same property at the higher 4.0% rate, they will end up paying back $85,030 more to the bank over the life of the loan. That’s about a surcharge of about 16% of the value of the home.

In order to avoid this surcharge entirely, the buyer would need to put down more money up-front. In this case, they would need to increase their down payment by about 9.35%, or about $49,462, to reduce the total amount financed and keep payments the same. That would bring the total down payment on this home to $155,262 (29.35%) — a lot of money.

Not all buyers can pay more. If the buyer is strapped for cash and wants or needs to keep both their monthly payment and down payment low, that means they will need to find a cheaper home. In this case, in order to still have a monthly payment of $1,784.23 at 4.0%, the buyer would need to spend a maximum of about $467,160 on a new home. That’s a decrease of almost $62,000 (12% ) of home value. Unless the buyer finds a deal, that is likely to result in a decrease of some desirable feature (fewer bedrooms or bathrooms, less back yard space, etc.).

These dilemmas all point to the need for close coordination between real estate agents and financing agents for home buyers in the current market, and for buyers to act quickly to buy available property before rates climb higher. Recent signals of higher inflation are pointing to the possibility of future rate increases, so if you are able to move, don’t wait to buy!

 

Note: The examples used in this article are based on national averages. Actual monthly payments vary widely and depend on many factors, including the lender and financing program, the buyer’s financial information, and the property being purchased. In order to find out more about your specific situation and purchasing power, it is recommended that you speak with a qualified financing agent.

References:

[1] https://www.nar.realtor/newsroom/pandemic-caused-buyers-to-seek-multi-generational-homes-sellers-to-sell-faster

[2] http://www.freddiemac.com/pmms/

[3] https://www.wgbh.org/news/local-news/2021/05/18/median-home-price-in-massachusetts-hits-record-high-of-529-000