Rising Interest Rates and the Impact on U.S. Homebuyers
Many variables go into a mortgage loan. Credit scores, debt-to-income ratio, property values, and borrower income are all considered when writing a loan.
One of the most important factors is interest rates. When interest rates rise, it can create various issues for home buyers, and while high interest rates are generally considered bad for typical homebuyers, you may find situations where you actually benefit from rising rates.
Rising Interest Rates? What to Expect When Mortgage Rates Go Up
Mortgage Rates Usually Rise as the Economy Improves
According to a March 2018 report from the Associated Press, interest rates are on a steady incline, which is putting pressure on the real estate market at a time when the industry usually ramps up activity for the spring season. The report states that Freddie Mac is claiming the average rate on 30-year fixed rate mortgages has climbed to 4.46%, which marks the highest average since January of 2014. A year prior, the average interest rate was 4.21%. For 15-year fixed rate mortgages, the average was 3.94% at the time of the report.
These higher mortgage rates are apparently having an effect on the overall housing market. This is because buyers face higher costs at times when interest rates go up. While the economy experienced steady gains, home purchases actually dropped by 3.2% from December 2017 through January 2018. In the previous year, home sales have seen a decline of almost 5%, which appears to be the biggest decline since August of 2014.
Before mortgage interest rates improved, the low rates are believed to have assisted the rise in home buying. Because rates were low, financial pressures on homebuyers were also down, but when rates climb, the cost of mortgage loans will steadily increase.
At the time of the report, mortgage rates have been increasing, with upward gains over the previous nine weeks. Interest rates on home loans often rise and fall with other economic factors, including inflation and interest on federal debt. Recent increases, however, have come even when the yield on a ten-year treasury note has stayed low.
It’s commonly accepted that as the economy improves, mortgage rates will also increase. Factors that indicate a strong U.S. economy, including rising wages and an positive outlook for growth, typically indicate that inflation may rise, which causes the U.S. Federal Reserve to raise interest rates to keep the prices stable.
There is a small upside for savers, however. As interest rates rise, you’ll get higher yields for the money you keep in your savings accounts. This, of course, isn’t a get-rich savings plan, but it doesn’t hurt to have a little extra cash in your account.
What Do Rising Interest Rates Mean to U.S. Homebuyers
But what does all of this mean to the typical U.S. homebuyer? It essentially means that when interest rates increase, buyers will be forced to pay more to borrow the money you need to purchase a home.
Let’s look at a typical example:
Say back in February of 2016 you had chosen to purchase a home worth $300,000 and you have a down payment of $60,000, which is 20% of the property value. This means you’ll need a loan worth $240,000. Say you choose a 30-year fixed-rate mortgage which, because of the time of your purchase as well as other factors, has an interest rate of 3.66%, a typical interest rate for the time. At this rate with this loan, you would pay $1,099 per month, roughly $395,640 total for the entire life of the loan. (This number excludes taxes and insurance.)
However, with just a small increase in interest rates, you can find yourself paying much more for your mortgages. Let’s say all the factors are the same, except for this loan you are paying 4.4% interest, which is close to the rates stated in the AP article from March 2018. (In fact, it’s slightly lower.) With this interest rate, you would pay $1,202 per month, roughly $37,000 more over the life of the loan. Clearly, this is a major difference, and it needs to be considered by potential homebuyers.
There is, however, the potential that some U.S. homebuyers may benefit from rising interest rates. Generally, as interest rates rise, demand can start to decline. This essentially means there is less competition for each house, which means you may have a less stressful and hectic home-buying experience, because you may not have to rush in a bid before the home is swept off the market, a situation faced by many buyers in hot real estate markets. While home prices are not tied to high or low interest rates, there’s also the chance that a lower bid may be accepted if fewer people are searching for homes, which is possible when rates are high.
As interest rates rise, your investment property could become more valuable. Property owners often benefit from interest rates because increases in occupancy and rental rates could make investment property more valuable. This is because when more people stay away from purchasing and choose to buy, there is more demand and the increase potential for better profits from your rentals.
Homebuyers will also find that adjustable-rate mortgages could become more expensive as interest rates rise. Adjustable-rate mortgages are tied to the Federal Reserve’s numbers, so monthly payments could steadily increase as interest rates rise. However, most ARM rates increase annually, so any increases will be staggered and infrequent.
As interest rates rise, you could also find that HELOCs are more expensive. Home Equity Lines of Credit could become more costly if interest rates are on the rise, so if you’re thinking of borrowing money against your home for home improvements or other purposes, it may be time to act if interest rates are expected to climb soon.
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