It’s a dreaded topic that many people really don’t want to have to think about, but one I have been very vocal with my clients about for the past year. So this post will focus on the basics, and what those interest rates really mean for your savings account. If you feel this topic is dry and boring, that is because for most people, IT IS. Money on the other hand, is an interesting topic for most people, as long as its how you can have more of it, while working less.
So here goes… As mortgage interest rates go up, your monthly payment will too, until you lock in a fixed mortgage interest rate.
Say you want to buy a home and want to borrow $100,000 from the bank. The bank says they will let you borrow the money at an interest rate of 3.25% and lock that rate in for you for the next 30 years while you pay that back in about 360 equal payments until it is paid off. That puts your monthly mortgage payment at $435.21.
Now lets say you wait till tomorrow to buy that SAME home, but tomorrow you go to the bank and interest rates have gone up to 4.25%. The same bank is willing to let you borrow that $100,000 at the new rate of 4.25%, meaning your new mortgage payment is now locked in for 30 years at $491.94 per month.
If you notice the difference in the numbers, the 1% rise in mortgage interest rates makes your monthly mortgage payment go up by $56.73. So over 12 months, you spend about $681 more FOR THE SAME AMOUNT OF MONEY BORROWED! To be clear, you get nothing extra for the additional $681 you spend. You don’t get a larger home, and you don’t get a more expensive home. We are talking about how buying THE SAME HOUSE, will cost you more money as interest rates rise.
Now, I was only speaking hypothetically about a $100,000 loan. To see how this plays out in today’s market, let’s say you are moving to Chicago’s North Shore where in October 2013, the Median Home Sales Price was $525,000. You put 20% down and borrow $420,000.
Watch how interest rates affect your payment on a $420,000 loan:
With an interest rate of 3.25% your payment is $1827
With an interest rate of 4.25% your payment is $2066
With an interest rate of 5.25% your payment is $2319
If you’re still with me, great and thanks for hanging in there! So now, how to save a ton of $$$$: When I first started talking about the effects of interest rates with my clients, it was still possible to get a 30 year fixed rate loan at an interest rate of 3.25%. Most interest rate forecasts we see today tell us that those days are gone. You missed that boat, but you can still catch this one.->Interest rates are bouncing around the 4.25% range at the time of this writing, and the forecasts we are seeing is that rates will eventually stabilize near the 5.25% range, this may be approximately 1 year from now, give or take, depending on how the economy performs.
Buying that $525,000 North Shore Home at today’s rates vs waiting to buy the same home until later when rates are forecast to be in the 5.25% range, will cost you approximately $91,118.88 MORE in INTEREST PAYMENTS ALONE, while paying down that home over 30 years at the fixed rate. Remember, we are talking about buying the SAME home with only a 1% change in interest rates. We are not even taking into account what happens if you wait and home prices rise.
If you look at the numbers from the home affordability perspective, lets assume that the bank tells you that you are qualified for a $1500 per month mortgage payment. This is how the interest rate will effect how much money the bank will let you borrow and in turn how much home you can afford.
Interest rate of 3.25% will afford a mortgage of $345,000.
Interest rate of 4.25% will afford a mortgage of $305,000. (You can now only afford a home that is $40,000 cheaper)
Interest rate of 5.25% will afford a mortgage of $271,500. (You can now afford only a home that is $33,500 cheaper)
So that shows you that as interest rates increase, to be able to stay within your budget of $1500 per month for the mortgage payment, you will need to look at homes that are priced less. That may mean that you may need to look at smaller homes if you want to be in a specific neighborhood, or you may need to change neighborhoods to an area where homes are cheaper if you want to buy a certain size home.
I have kept the details and the numbers pretty basic in this example. There are several factors that will affect interest rates and several other factors beyond the mortgage payment that you will want to consider. The interest rate and home purchase price you qualify for will depend on your financial situation. Contact a mortgage broker to find out what they can pre-approve you for and how comfortable you are with those payments. All numbers above are estimates and to be used for educational purposes only. Naturally, your savings will vary depending upon the price of the home and the interest rate.
Looking to buy in the Chicagoland Area but don’t know who to talk to about the process? E-mail me if you have questions about the process, what you can be doing to prepare for it, or who you can talk to in order to get pre-approved for a loan. If you’re not in the Chicagoland area, and would like to be put in touch with an agent in your area, let me know where you are looking and I can put you in touch with an agent in my network across the United States. The purpose of this post was to show you that a small change in interest rates will have a very large impact on the amount of money you spend over the life of the loan. Home affordability is most likely the best this generation will see, and affordability will only go down as interest rates and home prices rise.
If you’re still reading, congratulations, you’ve made it to the end and hopefully learned something new!
Paul Cionczyk is from the Millennial Generation. He is an Illinois Licensed Real Estate Broker and Realtor. Having graduated from the University of Illinois Urbana-Champaign with a Degree in Economics, Paul applies his knowledge in a “dollars that make sense” approach to help home buyers and sellers attain their home-ownership goals. Paul’s focus is on first time home buyers, and move-up sellers looking to get into Chicago’s North Shore area.
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