With the Federal Reserve indicating they are ready to increase interest rates, it’s time to take a serious look at your loan options, if you are considering a home purchase in 2017. Rising interest rates increase the cost of housing and can impact the loan amount you will qualify for.
Interest rates have held at all-time lows for over three years. Now that the economy is showing greater stability, there is less of a need to keep rates low. Rising short term interest rates will impact long term mortgage rates along with any variable rates, like credit cards and other lines of credit. As borrowing costs rise, you may find you have less discretionary income, impacting home buying and monthly mortgage payments.
Qualifying For a Mortgage
Debt to Income and Interest Rates are two of the key factors lenders evaluate when determining how much they are willing to lend for a home mortgage.
Debt to Income. This ratio takes your current or expected income and then divides it by current bills, plus the new mortgage payment. Income will be based on the employment contract, W-2’s, or recent tax returns. Current bills will be determined by debt that appears on your credit report. These include car, student loan, and credit card payments. Then they calculate the new mortgage payment including principle, interest, taxes, insurance, and mortgage insurance. This ratio will help determine the loan amount you can be approved for.
Interest Payments. Lower interest rates will result in lower payments and higher loan approval amount. Long term interest rates fluctuate daily, but have remained around 4% or even lower, depending on the day. At 4%, for every $100,000 borrowed you can expect a payment of around $477.42 for a 30 year loan. This means a $500,000 loan would result in a principle and interest payment of around $2387.10 and an $800,000 loan would have an estimated payment of $3819.36.
If the interest rates rise to 5%, then the cost of borrowing $100,000 goes up to $536.82. A nearly $60 increase for every $100,000 borrowed. On a $500,000 loan the increase is almost $300 a month more. These calculations are estimates and based on the loan amount, not the purchase price. Any down payment made would be subtracted from the amount borrowed. The calculation only includes principle and interest and does not add in the taxes and insurance payments (escrow) or any mortgage insurance payments that might be due, depending on the loan.
Ways to Lower the Mortgage Payment
Trying to time interest rates is not a very effective way to get the lowest rates because they change every day. Mortgage companies are very competitive and with rates widely available online, finding a lender you can trust and one that is easy to work with is more valuable than a 1/8th of a percent rate difference.
Effective ways to lower interest rates include changing the term. A shorter term, say 15 years, will have a lower rate than a 30 year loan, although the payment will be higher.
Another option is to consider a variable rate or interest only, instead of a 30 year fixed. If you only plan to be in the home for a few years these options offer a lower rate than the 30 year fixed and can either reduce your payment or provide a higher loan approval amount.
Consider the property taxes where you are looking to purchase. Sometimes buying in a neighboring county can save enough in annual taxes to make the commute worthwhile.
Choosing a loan program that does not require PMI (private mortgage insurance) with a smaller down payment can also be a way to increase the loan approval amount. Many Physician Loan Programs designed for new and existing doctors, do not require PMI (Private mortgage insurance)
Lastly, consider how large a home you need, versus what you will qualify for. Rising interest rates may cause you to reconsider the need to carry a larger mortgage. It may also require more thought and strategy, in order to purchase a home at a specific price point or to buy in a particular neighborhood you are seeking.