Buying a Home

How Low-Interest Rates Increase Buying Power

By May 26, 2021 No Comments

How Low Interest Rates Increase Buying PowerHow Low-Interest Rates Increase Buying Power

When buying a home, you learn quickly that low-interest rates are highly desirable. Most people understand that the interest rate ultimately affects the whole amount that you pay for your home over time. Still, interest rates also have an immediate impact on your purchasing power. Nothing affects a home’s affordability more than interest rates. After all, we live with the monthly payment, not the amount of the loan.

What Is An Interest Rate?

An interest rate is a way that a bank makes a profit on your loan. Mortgage interest is what a lender charges for giving you a loan to purchase residential property. To put it simply, it’s what it costs you to take out a loan. Interest is a percentage of the loan amount that the lender requires you to pay back above and beyond the amount of the money loaned. So a higher interest rate means that you’ll pay more money back over the life of your loan. This increases the total cost of your home purchase. On the other hand, a low-interest rate reduces the cost of borrowing and the total amount of interest you pay over time, which allows you to pay less for your home in the end. An interest payment also affects the amount of your monthly mortgage payment.

How Interest Rates Affect Your Mortgage Payment

There are four main components of a mortgage payment: principal, interest, taxes, and insurance. These four together are referred to as PITI. 

  • Principal- A portion of each mortgage payment goes toward the repayment of your principal balance. Your amortization schedule, or your loan repayment schedule, is structured where the amount paid toward the principal starts low and increases over time with each mortgage payment. In the first few years you own a home, more of your payment is applied to interest than principal. As time goes on, the payments you make in the later years of homeownership are mostly principal and less interest. 
  • Interest- Think of interest as the lender’s reward for taking a risk and loaning you money. The interest rate on a mortgage impacts the size of a mortgage payment: Higher interest rates mean higher mortgage payments. Higher interest rates also typically reduce the amount of money you’re approved to borrow, and lower interest rates will increase the amount you’re approved to borrow. If the interest rate on a $100,000 mortgage is 6%, the combined interest and principal monthly payment on a 30-year mortgage would be roughly $599.55—$500 interest + $99.55 principal. The exact same loan with a 9% interest rate will result in a monthly payment of $804.62.
  • Taxes- Property taxes calculated by government agencies fund public services such as schools, police forces, and fire departments. The government calculates taxes yearly and rolls them into your monthly payment. They divide the amount by the total number of monthly mortgage payments in a given year. The lender then collects the payments and holds them in escrow until the taxes need to be paid.
  • Insurance- Like your taxes, insurance payments are also made with each mortgage payment and held in escrow until the bill is due. There are two different types of insurance that may be included in your monthly payment. The first is property insurance, this type of insurance protects the home and its contents from theft, fire, and other disasters. The second type is something called PMI. This type of insurance is mandatory for people buying a home with less than a 20% down payment. PMI, which stands for Private Mortgage Insurance, protects the lender if the borrower cannot repay the loan. It also minimizes the default risk on a loan. PMI coverage drops once the borrower has at least 20% equity in the home.

This breakdown will help you better understand why a lower interest rate saves you money monthly, but more importantly, it can add up to huge savings down the road. So consider buying while interest rates are low.

Interest Rates And Home Buying

When buying a home, the mortgage interest rate can directly impact the amount of the loan you may qualify for. The higher the amount of the loan, the more an interest rate can affect your buying power. But what exactly is buying power? Buying power is the total amount you have access to each month for your mortgage payment, what you’ve saved for a down payment, and the money you qualify to borrow.

These individual amounts come together to impact your buying power. They tell you how much house you can afford and where you can buy. While your interest rate isn’t the only thing you take into consideration when purchasing a home, a lower rate may result in your ability to buy a higher-priced home. You can also receive an increased amount when financing. And just how much difference do varying interest rates make? Just a one-percent rise in your interest rate can reduce your purchasing power by ten percent or more.

How Much Difference Does A Point Make

Let’s look at an example. A buyer paid $457,000 for a house in March 2019 while interest rates were 4.4 percent, and their monthly payment becomes $2,500. A buyer who purchased the same house for the same price a year later in March 2020 while interest rates were 3.2 percent would have a monthly payment of $2,250. This allows them to save $250 a month or $3000 a year.

A buyer willing to pay $2,500 a month in March 2019 would be able to buy a home priced at $457,000. In 2020, the lower interest rates would boost their purchasing power significantly. That same payment would allow them to afford a home priced at $508,250.

Advice From A Seasoned Loan Officer

As Realtors®, we know the importance of staying up-to-date on the most current market data. This is important for us to do our jobs well, but also to educate our clients. We asked one of our favorite loan officers, Rich Bonn with Cross Country Mortgage, what we can expect in the coming months where interest rates are concerned; his answer is as follows:

“Although we are in a competitive market with rapid price escalation, there are no indicators for this price appreciation to slow down any time soon. We are anticipating prices to keep climbing even as rates start to rise. Not only is there an inventory shortage for buyers right now, but the last decade of significantly slower construction has left us with an overall single-family housing shortage. Especially as we see the millennials getting more serious about home buying. Because of this, as home prices appreciate, an increase in interest rates will impact housing affordability even more than in past markets. Homebuyers will have to pay more for the home of their dreams in price as well as payment.”

It’s important to use a reputable and experienced loan officer who’s on your side and has your best interest at heart. As Rich explains, “Buying a home is one of the biggest decisions that you make.  When you work with my team and me, you become a member of our family.  We are singularly focused on creating the best experience for you.  We look at all options available to us to make your home purchase fun and easy.”

Living Houston Continuously Watches The Market

The continued rise in interest rates will affect many people in the coming years and their ability to buy the home they want. High interest rates coupled with the housing shortage will make purchasing a home even more difficult in the coming months. Living Houston is here to assist you in buying or selling your home during this unprecedented time. Contact us for a consultation and for more information on what you can expect from the market in the coming months.

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