Everyone knows that interest rates are on the rise- the economy is doing well, and to match the price to borrow money with the demand for loans, rising rates are the variable that is manipulated. This increases a homeowner’s mortgage payment, but is it really that simple?
Looking at the Numbers
It’s easy to think about rising rates from the perspective of an individual homebuyer, concluding that higher rates mean a more expensive mortgage payment. This is true; the difference between a mortgage payment at 3.5% and 4.5% on a $200,000 loan is more than $100 a month. The factor that this train of thought leaves out is demand.
Imagine that someone is home shopping and they come across this scenario. They’re looking at a home for $250,000, so their 20% down payment would be $50,000. At a 3.5% interest rate, their monthly payment would have been $1,181, but now that rates are around 4.5%, the payment is $1,297. With their income, this payment is a little too pricy for them, and they move on with their search for a more affordable home.
After a few weeks, you’re looking to purchase, and you come across this same house. Since it’s been on the market for a while, the asking price has been lowered to $235,000. You contact the seller’s agent and realize that there aren’t a lot of buyers looking at the house. This home is a perfect fit for you, though, so you submit an offer for $225,000. The seller accepts, and a deal has been made!
The interest rate that your bank offers is 4.5%, the same that it was for the last prospective buyer. When you finance the home, you put down $50,000- a bit more than 20%, but this is what you saved for a down payment and are comfortable paying. Your monthly mortgage payment comes out to $1,170. How did you end up paying less with a higher interest rate?
Waiting it Out
Since you were able to scoop your home up for a lower price than the last buyer, you were able to reduce your mortgage payment even though interest rates rose. Plus, your down payment gave you extra equity on the reduced price, making your interest-accumulating balance lower. This is all a result of the lower price, which you were able to get because the higher rates drove some buyers out of the market. The key takeaway here; demand adjusted as interest rates increased.
This doesn’t mean that interest rates will drive down the value of homes. While you were able to buy your home at a reduced price, you did so with a value-buying strategy. You saved up for a down payment and knew what monthly payment your income would support. This home caught your eye when you noticed that the buyers it was attracting couldn’t quite afford it, so you went ahead and made an offer that would cancel out the cost of rising interest rates.
Don’t let rising rates scare you away from buying a home that you can get for a good deal. In this stage of an economic cycle, this is the strategy to use.