Prospective home buyers may feel disheartened when they see rates rise. Here’s what it really means for them.
Rising mortgage rates decrease how much home you can afford, but you have more flexibility than you might think because of how lenders qualify you.
Let’s recap the wild ride rates have been on since November, then review how this impacts affordability, and how you can qualify for the most home possible.
2017 rate recap and outlook
Mortgage rates rose .75 percent between the election and Christmas last year, driven by a belief that the new administration’s proposed policies of infrastructure spending, tax cuts, and deregulation would be inflationary if enacted.
Rates rise on inflation threats, and this is what happened post-election.
We said back then the dramatic rate spike might level off, and now that’s happening, albeit in a very volatile way. Rates are up and down daily as investors react to new government policies. One day investors bet inflation will be muted by policy delays or roadblocks (lower rates), and another day investors return to the post-election inflationary bet (higher rates).
The net effect is that rates are off post-election highs, and now are up about .5 percent since the election.
Rate volatility will continue as investors and the Federal Reserve try to predict rate direction under the new administration, so let’s see how it impacts your home-buying plans.
How rates impact home affordability
On a $350,000 home purchase with 20 percent down, a rate spike of .5 percent reduces the home price you can afford by about $17,000.
This measure can make you think you’re doomed to a smaller house or worse neighborhood. But if you understand how lenders think, you can find solutions.
Mortgage lenders use a debt-to-income (DTI) ratio to qualify you, meaning they divide your bills (for housing, car payments, credit cards, etc.) by your income to get a percentage of how much of your monthly income you spend on bills. Most lenders don’t lend to you if your monthly bills are more than 43 percent of your income.
If you earn $65,000 per year and have car, student loan, and credit card bills totaling $615 per month, you qualified for that $350,000 home purchase when rates were .5 percent lower, but now you don’t.
The reason: your DTI percentage was below 43 percent pre-election, but now it’s above 44 percent after rates rose.
On the surface, the only solution would be to reduce your purchase price by $17,000 to $333,000 to get your DTI back below 43 percent.
How to increase home affordability
But instead of reducing your price by $17,000, you can reduce your other non-housing bills.
For example, let’s say your credit card payment was $125 on a balance of $3,125. You need to get that payment down to $45 to qualify for your original $350,000 home purchase price, and you can do so by paying down the balance by $2,000.
That’s a lot better than reducing your purchase price by $17,000, and if you’re light on cash, you can negotiate a seller credit at closing to recoup the $2,000.
How to make the right decisions
Just like all real estate is local, all lending is individual. So don’t automatically assume rising rates push down the price you qualify for.
A good lender will examine your full financial profile and goals, then dive into the math to find solutions for you.
Looking for more information about mortgages? Check out our Mortgage Learning Center.
About the author
Julian Hebron is a mortgage banking executive and writer based in San Francisco. He’s the editor of influential consumer finance and housing blog The Basis Point, and EVP of Sales with RPM Mortgage. His work is regularly cited by CNBC, The Wall Street Journal, and Marketwatch. Follow him on twitter: @thebasispoint