5 things to know: Interest rate increases diminish your buying power.
This week we are discussing the real ways you could be affected by interest rate increases. I had a great discussion with Andrew Cady- Personal Mortgage Advisor about where rates are headed and what that means for you. Here are the highlights.
- What are we even talking about here?
Not everyone is on the same page with understanding how mortgage interest works. For the sake of this blog, the basics are: your mortgage interest rate determines the annual amount of interest you will need to pay on the amount you borrow, the higher the rate the higher your payment will be on the same amount of money. The schedule of payments (amortization schedule) that breaks down exact amounts of interest vs principal (the amount you owe) is given to you at closing. A higher rate will reduce the amount you can borrow based on how much you can afford to pay each month. This is what we mean by “rate-increases diminish your buying power”. We’ll get into some numbers to really flesh this out.
- How much?
Andrew made it clear that determining exactly how much a rate-increase affect your buying power “is NOT a Science” but there are some general rules. To give you an idea of how much rising rates affect you, Andrew uses this rule. If the rate increases 1% we can assume your buying power (the amount of money you can borrow) to be reduced by about 10%. If you are approved to borrow $500K when the rate is 4% and the rate increases to 5%, your approval amount may very well to be reduced to $450K. A 50,000-dollar difference is significant. At $250K the difference could be $25K. That might mean the difference of a neighborhood, updated kitchen and bathrooms, a pool or number of bedrooms. It is certainly not nothing.
- Why are rates increasing?
The Federal Reserve (aka the Fed) sets two rates, “The Federal Funds Rate” and “The Federal Discount Rate”. The Federal Funds Rate (aka Fed Funds Rate) is the rate that banks charge each other for overnight loans. The Federal Discount Rate (aka Discount Rate) is the rate that the Fed charges banks to borrow money from the Fed. The Discount Rate is a little bit higher because the Fed wants to encourage banks to borrow from each other first. What does this have to do with you? All interest rates are adjusted based on those two rates. Including mortgage interest rates. The Federal Reserve has been slowly increasing these rates for the last several months and has stated that it will continue to do so as long as it thinks the overall result is not detrimental to the economy. Many in the mortgage industry don’t foresee them backing off anytime soon.
- What can you do?
If you are considering buying a home soon, lock in a rate now. Individual lender’s guidelines may vary but Andrew suggests locking in the rate 60 days before your closing. Most lenders offer 30, 60, and 90-day interest rate locks. 120-day locks may be available but are generally cost-prohibitive. The lock guarantees your rate will not change for that period. If the process takes a bit longer than expected and your lock expires it can be extended. Some lenders may offer a complimentary extension for 10 more days. Often you can extend three times, in 10-day increments, up to 30 days. Extensions, again just as a rule of thumb, cost about .025% of the loan value per day ($25 per day per $100k). After the maximum extension time frame, the lender will increase the rate to the current market rate.
- Don’t panic!
I am sure you have heard it many times on the radio or television “we have been in a period of historically low rates”. According to Andrew, from 2000-2010 the national average rate was 6.91%. We aren’t near that right now, he predicts that 5%-5.5% may be the new normal. History has shown that people are still willing to buy homes when interest rates are 18%-20%. We are currently at a 4-year high, at least it is not 20%, but it’s not 3% like it was a few years ago either. When rates are held too low, anyone who invests in fixed rate investments are not making enough to justify the investment. That includes mortgage lenders, but it includes many people with retirement accounts too. While rate increases aren’t great for those looking to get a loan, if done within reason they are a good thing over-all.
It is complicated stuff, that’s why hiring a professional that you trust is so important. I want to thank Andrew Cady for taking some time to discuss this with me. If you don’t already have a Real Estate agent, we hope you will consider The Stahl & Stahl Group, we would love to help. If you have any questions or suggestions for things I missed, comment on our Social Media pages. While you’re there, give us a ‘’like”!
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