“What will happen to my buying power when mortgage interest rates start to rise? How much longer can I wait to sell my home because I want to receive the highest return?” These are some of the questions that are currently asked at our company, and we would like to address them here if there are others with the same concerns.
Mortgage interest rates have historically been kept significantly low for nearly a decade. The era of such low rates was primarily due to the economic recession that we experienced towards the end of the year in 2007. Since then, the economy has remarkably recovered and stabilized. Fast forward to today, the majority of people wonder, “How much longer will the Federal Reserve (“the Fed”) keep the interest rates low?”
In a quick response, no one really knows how much longer interest rates will be kept low. There are a multitude of factors to consider when the Fed will start increasing the interest rates [i.e., how is the 10-year treasury bond responding (the average mortgage is paid off or refinanced within 10 years – so this is a good indicator to measure interest rate change), how strong is consumer spending, how are the inflation rates impacting the national economy, how much have: jobless claims, Gross Domestic Product (GDP), home sales, consumer confidence, and other data on the economic calendar improved because all these factors influence mortgage rates significantly]. Even though we are not sure, “When will interest rates rise?” I want to provide you an analysis on, “When mortgage interest rates do rise,” how that will impact your buying power. Additionally, for those who are on the fence on selling their home and are waiting for the “right time,” this is also a noteworthy analysis for you to consider because the market can shift from a “seller’s market” to a “buyer’s market” instantaneously and your negotiating power can be swapped suddenly.
Mortgage rates increase and decrease in a denomination and multiple of eighths of a percent (.125%, .25%, .375%, etc.). Working for various lending institutions for the past 9 years, I learned that the maximum, common, debt-to-income (DTI) ratio a lender will lend is approximately 45% (the DTI ratio is a percentage figure that lenders will use to ensure that they are not over-extending credit to you when your reported income may not afford the requested additional debt). With this figure in mind, I stabilized the DTI ratio at 45% and analyzed two different scenarios to see if there are any conclusive results: (1) how much more income will one need to make to keep the same purchase power and (2) how much buying power will one lose if one’s income does not change. I performed such an analysis on three different loan amounts. The loan amounts that I chose were to be inclusive in my research, and those amounts were: (1) $417K, (2) $625,500, and (3) $1M. (Conforming loan amounts for 2016 are considered to be less than or equal to $417K, High-Cost Loans: $417,001 - $625,500, and Jumbo loans: $1M and above). Here are the results:
Based on the above analysis, you can notice that the low-interest rates today can allow you to borrow more money (“higher purchase power”); rather than, when the interest rates start to rise your buying power is taken away if your income does not increase. One notable result from the above analysis is that if you want to be able to afford the same purchase power, for all three scenarios, your yearly income needs to increase by 1%, per .125% mortgage rate increase. This proportionate figure is important to be aware of because realistically you may not be able to increase your yearly income by 1% to afford such a drastic drop in your purchase power. Additionally, often times, mortgage interest rates do rise in .25% increments. Meaning, you’ll have to increase your yearly income exponentially by 2% to sustain your purchase power in that one day’s worth of interest rate change.
In similar, if a seller is waiting to sell their home for the highest market value, one is taking a risk because a “seller’s market” can shift to a “buyer’s market” when there is an excess of homes in inventory (excess supply), homes are not selling quickly, and the buyer now has less purchase power to buy your home (demand is low). When there is an excess in supply of homes and the demand is low, the value of your home will decrease. This change in the market can suddenly occur.
Another notable result is that if your yearly income does not increase when the interest rates start to rise (which typically does not happen), your buying power is decreased by approximately 1% per .125% mortgage increase. [i.e., at today’s 4.00% interest rate, 45% DTI, you can potentially purchase (depending on your other credit qualifications) a home for $781,875; however, at an increase in interest rates to 4.125%, 45% DTI, your potential qualification drops to $774,056. This is a 1% decrease in your purchase power)]. This exponential, proportionate, figure is to your disadvantage when the interest rates start to rise. Hence, a steady decline in buying power for all three figures.
Additionally, on top of your current buying power, with these historical mortgage interest rates, you can also save significantly on the total interest of your loan; rather than, if you waited and the interest rate has risen, your total out of pocket expense will be higher because you will be paying more in interest over the life of your loan.
Our national economy is a cyclical economy, where our economy goes through expansion, progression, stabilization, and regression and back to expansion to repeat the cycle. Knowing that the Fed can increase the interest rate in any day, one might have to wait for another cycle to come around to be able to buy at such an advantage point; which, you will have to ask yourself: Is it worth waiting for another cycle to buy a home, when the historical values of homes might rise then?
Contact us at (949) 424-7282 or email: Info@MoaddabRealty.com so we may help you save money and time in buying your dream home!
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