You’ve heard the stories of interest rates in the 15% to 18% range in the 1980s. Let’s hope those astronomical and debilitating rates are in the past forever.
But most people don’t realize that rates in the 3’s and 4’s are not the norm either. We’ve seen these rates over the past six years only due to government involvement and insecurity in world markets. For a time, the Fed purchased upwards of $85 billion worth of mortgage backed securities (MBS) and Treasury bonds per month. That put demand on securities, driving down mortgage rates.
When the bond buying program ended in October 2014, instability on the world scene kept rates low. Conflict in Iraq and Syria, as well as financial turmoil in Europe caused a rush on U.S. bonds, again driving down mortgage rates.
But what happens if and when the world returns to relative normalcy?
U.S. Economic Strength Could Lead to Higher Mortgage Rates
Here in the U.S., the unemployment rate stands at 5.3%, down from a high of 10.0% in 2009. The economy is adding jobs each month in consistent fashion.
While we’re a ways off from a truly robust economy, the U.S. is on the path to recovery. As things improve, investors will put their money into more risky securities like stocks and less into safer securities like MBS and Treasuries. We’ve already seen heavy investment in the stock market which was up more than 11% in 2014.
This trend will put less demand on safe securities, which will drive up mortgage interest rates.
Average Historical 30-Year Fixed Interest Rate
Although we’re not likely to see rates in the teens (we hope), rates will gradually rise to the 6% range before too long.
Rates have been so low for so long that many of today’s homebuyers assume it’s always been this way.
Nothing could be further from the truth.
Since Freddie Mac started their Primary Mortgage Market Survey in 1971, the average 30-year fixed rate over those 43 years has been 8.55%. In fact, we saw a rate below 6% for the first time ever the week of September 27, 2002 when the 30-year fixed rate hit 5.99%.
You might say that the average rate is skewed higher because of the hyper-inflated rates of the ’80s. Ok, let’s just take the average rate since January 1994 – only the last 20 years – which removes the ultra-high rates of the prior period. We still end up with an average rate of 6.29% over the last 2 decades.
We are certainly headed for mortgage rates more in line with these averages. Truly, the times in which we live where we’re seeing rates in the 4’s is an economic anomaly.
Mortgage Rates and Your Buying Power
So how do rising rates affect your buying power? As you might guess, you can buy less as rates rise.
What most home shoppers don’t realize however is how dramatically their buying power is diminished with relatively small rate increases.
Check this out. Let’s imagine you had $1,200 per month to spend on your principle and interest payment. (Keep in mind this number doesn’t include things like property tax, insurance, mortgage insurance, or HOA dues).
That $1,200 per month can go a long way when rates are low. For instance, if you locked in a 30-year fixed mortgage at 4.5%, you could buy a house for $295,000 if you had 20% down.
But let’s say rates rise to 5.5%. Still a great rate, but 1% higher than you planned.
Now you are limited to a purchase price of $265,000, again assuming 20% down.That’s a 10.17% reduction in buying power and $30,000 shaved off your maximum purchase price.
At $1,800 per month and 20% down, you could buy a home for $445,000 with a 4.5% interest rate. But at 5.5% your maximum home price is now $395,000 – an 11.24% reduction in buying power.
At the lower end of the spectrum, $1,000 per month would buy you a $235,000 home at 5.0% but just a $208,000 home at 6.0%. That’s an 11.49% reduction and in some areas could make the difference between getting into a home or not, or settling for less house.
|
Max Principle & Interest
Payment
|
4.50%
|
5.00%
|
5.50%
|
6.00%
|
|
$1,000
|
$245,000
|
$235,000
|
$219,000
|
$208,000
|
|
$1,200
|
$295,000
|
$280,000
|
$265,000
|
$250,000
|
|
$1,400
|
$345,000
|
$325,000
|
$310,000
|
$292,000
|
|
$1,600
|
$395,000
|
$372,000
|
$350,000
|
$335,000
|
|
$1,800
|
$445,000
|
$420,000
|
$395,000
|
$375,000
|
|
$2,000
|
$495,000
|
$465,000
|
$440,000
|
$415,000
|
High Rates Affect High Loan Amounts the Most
As you move to higher purchase prices, the sheer dollar amount that is shaved off your purchase price by rising rates is pretty incredible.
You could buy a $420,000 home at 5.0% if your budget were $1,800 per month. But at 6.0%, your purchase price is $375,000, a reduction of $45,000.
At a $2,000 per month payment, your maximum purchase price is cut by over $50,000by a 1% increase in rates.
These are big numbers and could affect your ability to get into the home you wanted, or into a home at all in higher priced areas.
A Higher Rate = Not the Home You Wanted
As rates rise and your maximum purchase price falls, you could find that you can’t afford the kind of home you wanted. You may have to postpone your plans to buy a free standing home (also known as a single family home) and opt for a condo or attached townhome instead.
While it’s not the end of the world and still a good investment, it can be disappointing to settle for less than will really suit your needs.
What’s worse is that buying a home that doesn’t fully suit your needs can be expensive. For instance, you buy a condo then have a couple kids and need to sell and buy bigger. When you sell the condo, you lose 9% to 10% of its value on agent fees, taxes, and escrow fees. That’s between $18,000 and $20,000 on a $200,000 condo.
If you could have purchased the right sized home in the first place, you could have saved the time, money, and hassle of selling and buying again.
Or higher rates could force you to buy an older home that needs work. Remodeling fees quickly add up to five figures even on small projects. Older homes are typically less efficient, leading to higher heating and cooling costs.
Higher interest rates that cut into your purchase price can cost you in many ways.
Buy Before Rates Rise
You could probably guess where this is headed with this article. Yep. I’m going to tell you to buy a home sooner rather than later. The sooner you buy, the less likely you’ll be hit by rising rates.
Of course you need to take a look at your economic stability and your plans to stay in one spot for at least 7 years. But, if you’re fairly certain you can handle a home, but are still waiting, I would advise you to move up your plans to start looking for a home and getting prequalified for a home.
Like I said, we’re living in a real economic anomaly that we won’t experience again in our lifetimes. Soon mortgage rates will be in the low- to mid-5’s by mid-2014, and probably closer to 6% in 2015. If the economy continues to recover, we could even see rates in the 6.5% range by mid-2015.
So again my best advice for anyone looking to break into homeownership is “carpe diem” – seize the day while rates are low. When rates normalize, you won’t be sorry you did.
Tim Lucas (NMLS #118763), Editor
Tim Lucas is a licensed loan officer with over 12 years of experience as a loan originator, processor, and team manager. Get a
live rate quote for your home purchase or refinance at MyMortgageInsider. Visit Tim on
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