Rising Interest Rates: How to Afford Your Wishlist Home
How Interest Rates Affect Your Home Buying Power
With interest rates predicted to climb by half a point in 2017, prospective home buyers are starting to wonder how they’re going to be able to afford their wishlist homes with interest rates on the rise. But, before you fall victim to mass hysteria, it is important to first know how interest rates affect your buying power. So what happens when the interest rate jumps up by half a point or by a full point?
What Rising Interest Rates Mean to You
One of the most important factors that lenders use to qualify home buyers is a thing called debt-to-income ratio, or DTI. The lower your DTI is, the greater chance you will be approved for a mortgage. Most of today’s lenders put a cap on the allowable debt-to-income ratio at 45%. This means that no more than 45% of the applicant’s monthly income should go toward paying off their monthly debt obligations.
Expenses included in your DTI ratio include things like your car payments, student loan payments, monthly minimum credit card payments, child support or alimony costs, as well as the prospected house payment, including any taxes and insurance.
To determine your DTI, you add all of your monthly debt obligations together, and divide that number by your monthly income.
If your DTI is in an acceptable range, you’re one-step closer to owning your dream house. But, it is still important to know how the rising interest rates will affect your buying power because as rates rise, your buying power decreases.
Here’s an example. If your gross monthly income is $5000 and your monthly debt obligations total $2,250, then you have a DTI of 45%. If you’re looking for a mortgage payment of $1,900, then here is how the interest rate is going to affect your buying power:
At 3.875%, the maximum home price you will be able to afford with a $1,900 monthly mortgage payment is $380,000.
If the interest rate climbs to 4.375%, then the maximum you will be able to afford is $363,000 at your $1,900 goal. That’s a $17,000 drop in buying power.
If the interest rate climbs even higher, to 4.875%, then your maximum amount falls to $345,000.
So, a one-point increase in the interest rate will cost you an incredible $35,000 in buying power!
What You Can Do to Still Afford the Home You Want
If you’re in the market for a new home and you have a dream home on your wishlist, then now is the time to act because we are in a narrow window of opportunity in which buyers can take advantage of the current low rate and still get a home at a reasonable price.
There is risk in waiting, but even if you can’t go all-in on your dream home right now, there are still some things you can do to afford the home you want, despite the rising rates.
Start by Saving More
For starters, you can save more money so you can put a larger down payment on the home you want. This will help offset the rising interest rate and allow you to afford a home you might otherwise not qualify for. Another option is to add a non-occupant co-borrower, like a parent or other relative, into the loan. This will let the lender take their income into consideration and this will help lower your debt-to-income ratio so you can get approved for a higher amount.
There are also certain mortgage options you can choose that might help your chances of affording the home of your dreams. For instance, you can opt for a 5- or 7-year adjustable rate mortgage (ARM). This type of mortgage has lower rates and payments for the first five or seven years.
Another option is an 80/10/10 piggyback mortgage. This is a good choice for someone looking to put less than 20% down on their home. With this type of plan, the buyer puts 10% down, then gets an 80% first mortgage and a 10% second mortgage. By splitting up the mortgage, the total monthly payment may be lower than it would with a single loan, because you may be able to avoid being charged mortgage insurance.
Of course, while these options are available, the best bet is always the safest and surest – buy while the rates are historically low and the prices are reasonable. It’s your best chance at getting your wishlist home.
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