Wednesday, November 24, 2021 / by Jordan LaFond
How Interest Rates Affect Your Buying Power
As you think about making a home purchase, whether it is your first home or one of many, you need to consider what type of home you can afford. Most homebuyers choose to finance a portion of their purchase since many Americans do not have the cash to buy a home outright. From market dynamics to interest rates, many factors contribute to the type of home you can finance. So, what exactly is buying power? Buying power at its roots is the available money you have each month to put toward a mortgage after your other debts have been paid off (i.e. car loans, student loans, rent, etc.) Keep in mind that your buying power focuses on more than just the sale price; you also need to factor in taxes, insurance, repairs, and other expenses related to owning a home.
Determining Your Buyer Power
Determining what you can afford from a lending perspective is based on many considerations. Gross income, debt, assets, credit score, and interest rates are the key factors your lender will look at when calculating your pre-approval. Lenders use these indicators to find a monthly payment that is affordable based on your current situation. Using the PITI model, Principal, Interest, Taxes, and Insurance, your lender can accurately calculate the monthly loan payment you qualify for. They then work backward to reach a total purchase price that you are eligible for. So, what does this have to do with interest rates?
Buying Power Example
Interest rates are heavily tied to your buying power and fluctuations and affect the type of home you can buy. If all else remains constant, interest rates work inversely to buyer power. When rates rise, your buyer power falls, and vice versa. See the impact changing interest rates have on your buying power in the example below.
In this example, a homebuyer applies for a mortgage. The lender determines that they qualify for a $375k* home at a 3.25% interest rate with a $75k down payment (20%) on a 30-year loan. Should the interest rate rise half of a percent, to keep the same monthly payment and same down payment, the homebuyer would only qualify to purchase a home at $357k*. If we take the same scenario and say that interest rates increase a full percent, the buyer would only qualify to receive a loan for a home valued at $340k*. As you can see, even minor fluctuations in interest rates can have a substantial impact on your buying power. (*Numbers rounded to nearest thousand)
Hot Market Fueling the Fire
In today's market, the timing around locking your interest rate in is of keen importance for borrowers to discuss with their lenders. With multiple offer situations on homes in Vermont, we have seen homes selling well over their original asking price. For example, in October 2021, homes in Chittenden County had an average list-to-sale price ratio of 103.9%. With the average home closing at 4% above the asking price, you will need to factor in the rise of value into your home search. If this tight market continues at the same pace and interest rates go up on top of that, homebuyers will see an overall decrease in buyer power and may not qualify for the dream home they want. As a result, buyers may need to reconsider their desired parameters such as location, home size, and amenities. While the current market climate may seem daunting, affordability across the market has remained high.
The Existing Lending Climate
Interest rates have fluctuated dramatically throughout history and once were as high as 18%! With historically low rates available, buyer power has trended upwards, allowing buyers to expand their search for homes that they would not have otherwise been able to afford. If you are interested in seeing what you can afford, reach out to a lender to understand your current buying power.