How Much House Can You Afford in Today’s Rising Rate Environment?
Whether you’re buying your first home, trading up or thinking about purchasing a second home or rental property, interest rates play a significant role in determining how much house you can afford. That’s because even a moderate increase in interest rates can drive mortgage rates up, which can add hundreds of dollars to monthly payments and thousands more in interest over the life of a loan.
Throughout much of this year, inflation has been a key driver behind rate increases. The average rate on a 30-year mortgage the week of August 29, 2022, was 5.84%, up from 5.63% the previous week, and 2.81% higher than the 52-week low of 3.03%.1
Understanding how much you can comfortably afford is critical for ensuring you can continue to enjoy the lifestyle you desire today and years from now. When weighing credit applications, lenders consider your debt-to-income (DTI) ratio in addition to your credit history. Many use the 28/36 rule which states that no more than 28% of gross monthly income should be spent on total housing expenses and no more than 36% on total debt service, which is defined as housing plus other debt, such as car loans and credit cards.2 However, the amount consumers may qualify to borrow—and what they can truly afford to pay each month—can vary greatly. Many borrowers experienced that during the overheated real estate market in 2020 and 2021. As demand for housing outstripped supply, limited inventory led to panic buying and bidding wars, with many buyers paying more than they originally intended. In fact, a survey of U.S. homeowners who bought homes during the past two years reported that 7 out of 10 experienced some level of buyer’s remorse, with 30% saying they spent too much money. According to the survey:3
If you’re in the market to buy a home, consider the four steps below to help get the biggest bang for your mortgage buck.
1. Set a realistic budget.
Monthly principal and interest payments seldom tell the full story where affordability is concerned. That’s because there are a number of considerations that don’t figure into your monthly mortgage payment, such as the cost of furnishings and appliances, or whether the home requires repairs before you can even move in. What about monthly utility bills? Will they be higher or lower than what you’re currently paying? Have you estimated costs for regular home maintenance, landscaping, house cleaning and more? Factoring the various costs of home ownership into your household budget can help you stay on track toward your financial goals while avoiding unnecessary debt, like relying on credit cards to pay for unexpected or unbudgeted expenses.
2. Shop lenders.
Comparing mortgage rates and lenders can result in significant savings, especially in a rising rate environment. Be sure to read the fine print and ask questions. While advertised rates may appear similar, each lender has its own fee schedule. When you’re ready to start gathering quotes, make sure to submit all of your lender inquiries during your “rate shopping window” to avoid a negative impact on your credit score. That’s typically a period of 14 to 45 days where the credit bureaus will treat multiple similar inquiries as one hard inquiry instead of multiple inquiries.4
3. Review your options.
Most lenders offer a variety of loan options and durations. Each type of loan will have a different impact on your budget. For example, with a fixed rate loan, your interest rate will remain the same for the duration of the loan, whether that’s 10, 15 or 30 years. Adjustable-rate mortgages generally offer lower introductory rates, but your payment may increase or decrease over time as interest rates rise or fall. Ask your lender to walk you through the pluses and minus of each of the loan options available to you, so you can make an informed decision based on what best fits your needs and budget.
4. Get preapproved.
While cash buyers have the most leverage when negotiating real estate, a cash purchase is not practical for most buyers. However, a lender prequalification letter can significantly increase your buying power in a competitive market by assuring sellers that you’re a serious buyer with the financial resources to move forward with a purchase. Generally, this document states the amount you are qualified to borrow based on the lender’s preliminary review of your finances—typically your income, debt, assets and credit history. Keep in mind, a prequalification letter is not a guarantee that your loan will be approved. Lenders reserve the right to deny a loan at any point in the application process based on new information or changes in an applicant’s income, financial circumstances, marital status, etc.
Ready to strategize on ways to finance your dream home? Call the office to schedule a time to talk.
1 ”Mortgage News – Rates Surge.” Bankrate, 7 Sept. 2014, www.bankrate.com/mortgages/analysis/
This information was written by KRW Creative Concepts, a non-affiliate of the Broker/Dealer.