How Do Mortgage Rates Affect the Purchase of a Home?
There are many factors which determine how much you can afford to purchase - things such as income, down payment, outstanding debt, credit scores, and mortgage interest rates.
Some of the determining factors in qualifying for a purchase of a home is income and debt. Lenders will, in part, use debt-to-income ratios to determine how much mortgage you can afford. Generally, most lenders will limit your "front end" or housing ratio to no more than 31% of your gross income. (For self-employed borrowers, that will be 31% of their net income.)
The housing ratio will include the monthly principal and interest payments, 1/12th of your annual property taxes and homeowner's insurance premiums, as well as any mortgage insurance premiums and/or homeowner's association dues. The greater income you have, the more house you can afford to purchase.
The "back end" or total debt ration will include not only your housing payments, but other monthly debt obligations as well - obligations such as car loans, student loans, credit card payments, and so on. The more debt you have, the less house you can buy.
Another factor to consider is the term of the mortgage and the interest rate. Both the term of the mortgage as well as the interest rate will have an impact on your total monthly mortgage payment. The longer the term, the more house you can buy because your payments are stretched out over a longer period of time. And, the higher the interest rate, the less house you can purchase with a given income because you will have higher monthly mortgage payments.
To show you the impact mortgage rates have on how much house you can afford to buy, take a look at the following charts.
The first chart is the mortgage affordability chart. For this example, I used an annual income of $75,000, a front end housing ratio of 31%, and assumed that property taxes and homeowner's insurance premiums on a monthly basis consume 25% of the monthly housing payment.
The chart shows that for a 30 year fixed rate mortgage at 4.5%, you can afford a $286,790 mortgage. At 4.0%, you can afford a $304,373 mortgage. That's a $17,500 difference. But at 5.5%, you can only afford a $249,005 mortgage.
What does that mean for the purchase price? Assuming a 20% down payment, for a 30 year fixed rate mortgage at 4.5%, you can afford a home for a sales price of $358,488. At 4.0%, you can afford a home with a sales price of $380,467 mortgage. That's almost $22,000 more house you can buy. But at 5.5%, you can only afford to purchase a home for $311,256.
If mortgage rates rise, and if your income doesn't, you won't be able to afford to buy as much house as you can now. In the following chart, you can see the effects that interest rates have if your income remains the same.
In this example, I used a $300,000 mortgage and a $375,000 purchase price - again assuming a 20% down payment. At an interest rate of 4.5%, you need to earn only $78,454 annually. But if you wait until mortgage rates go up to 5.5%, then you will need to earn $87,916 annually. You will need a 12.1% raise in your income to be able to afford the same house at the higher rate.
The purpose of the charts isn't to show you how much home you can afford to buy based on a particular income, mortgage term and interest rate. Rather, these charts show you how much your buying power can be affected as mortgage rates change - either up or down.
If you're thinking about buying a home, now may be more advantageous to you than if you continue to wait. Why? Mortgage rates are at their lowest in more than 50 years. In addition, prices of homes have come down quite a bit in many areas over the past few years, thus making many homes much more affordable today.
Please contact me if you have any questions about the mortgage analysis.
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