What If Interest Rates Rise?

In today's housing market high demand and low supply have caused a constant and impressive rise to the average list price. According to Zillow, in September of 2015, the median list price in Boston was $550,000. Today, the average list price is $629,000.  A 79-thousand-dollar increase to the average price tag is easy to see and understand in regards to affordability. But what happens when interest rates begin to follow this trend? Will you still be able to afford the home you want? Will you still be able to qualify for the same loan?

Example: A Mortgage for Donald

    Donald has been saving for years and has $100,000 for a down payment. He has good credit and his loan officer has told him he can qualify for a mortgage payment of $2,000 a month.  Donald estimates the taxes will be $400 a month and the insurance will be $100 a month. Donald's Pre-Approval has an interest rate of 3.5%, a sale price of $433,600 and a loan amount of $333,600-. This scenario has a Monthly payment is 1,998.01, so Donald can also afford to buy two extra cups of coffee every month (Donald drinks very cheap coffee). 

   But wait! Before Donald is able to lock in his interest rate, the Federal Reserve raises the interest rates. Suddenly, Donald learns the 30 year fixed interest rate has changed to 4.5%. Donald has a new Pre-Approval. It says, at 4.5% interest rate, he can only purchase a home listed for $396,000 and borrower $296,000. Taxes and insurance estimates haven't changes, so his payment would be 1,999.78. For just a one percent hike in the interest rate, Donald loses $37,600 in buying power (and both cups of coffee) for a similar payment.

In the chart below, we see the affect interest rates play on our buying power. The monthly payment on all of these scenario are still just under $2,000.00.

You may wonder why this is so important? Well, if home prices remain in an upwards trend, your monthly payment of $2,000 allow you to borrower less and less, and could even push you out of the market completely.

 

It may feel as if financial institutions have cried wolf in regards to rising interest rates. Though still historically low, interest rates have fluctuated with a gradual rise. Within the last few weeks, proposals to raise interest rates have gathered supports from top financial leaders. Even the Federal Reserve Bank of Boston President, Eric Rosengren has plainly showed his support. Last Friday in an address to the South Shore Chamber of Commerce, Rosengren said"A failure to continue on the path of gradual removal of accommodation could shorten, rather than lengthen, the duration of this recovery". As a voting member of the Federal Open Market Committee, who helps determine the factors that raise and lower rate, his public advocacy for the raise has marketers even more convinced the rate hike is on the horizon.