Consumers are aware that interest rates are increasing, but very few understand how costly these seemingly small increases can be over the life of a 30-year mortgage. If you are thinking you may want to wait a year to buy, you may need to rethink your position.
Experts believe that interest rates will increase by another quarter point before the end of 2018 and that another three rate hikes will follow in 2019. This means today’s rate of 4.85 percent could be 5.85 percent a year from now.
This one-point increase is much, much bigger than most people realize, costing borrowers up to 23 percent more in terms of interest paid over a 30-year mortgage. Depending on the size of the loan ($400,000-plus), that amount could easily exceed $100,000 or more in additional interest.
In order to get a clear picture of what waiting could cost you, do the following exercise:
- First, use an online mortgage calculator to determine their current monthly payment. Be sure to use an amortization calculator that also totals the amount of interest paid over the life of the loan.
- Repeat the process, except increase the interest rate one full point.
- Once you have found the monthly payment for each set of interest rates, multiply the monthly payment for each by 12 to determine the amount of the annual payment.
- Subtract the total amount of interest paid at the lower interest rate from the total interest paid at the higher interest rate.
Example: For a $250,000 purchase price with $200,000, 30-year, fixed rate mortgage:
Understanding What Higher Costs Mean
The rule of thumb for conforming Fannie and Freddie Mac loans is that your front end ratio (your proposed monthly payment), cannot exceed 28 percent of your income.
In the example above where the interest rate is 4.83 percent, to determine the front end ratio, divide the total annual payment by 0.28 (28 percent) to determine the total amount of income required for the borrower to qualify.
In other words, a borrower who makes approximately $45,129 annually in 2018 would have to make $50,443 the following year to qualify at the increased interest rate for the same $200,000 loan amount in 2019. (This is provided that their backend ratios, i.e., their total debt payments including, their mortgage, do not exceed 40 percent of their income.)
According to the amortization calculator, the difference in total interest paid over the life of the loan is $44,773 ($223,839 – $179,066) or approximately 23 percent of the entire loan amount.
If Rates Increase By 2 Full Points
If the rates increase two full points from 4.83 percent to 6.83 percent, the total interest paid over the life on that $200,000 mortgage will be $270,825.
That’s an additional $91,759 in interest or almost 46 percent of the $200,000 loan amount!
Buyers Sometimes Worry That Prices May Decrease.
The current prediction from the National Association of Realtors (NAR) regarding price appreciation is that 2018 prices will be up 4.7 percent nationally and will increase by 3.1 percent in 2019 and 2.7 percent in 2020.
While these numbers will vary widely across the country, the average price gain is predicted to be 5.8 percent over the next two years.
Consequently, the true cost of waiting to purchase for one year would be the 23 percent of additional interest plus whatever the predicted increase in prices would be. Adding the 3.1 percent median increase above to the additional interest they would pay, that’s 26.1 percent.
Example: $250,000 purchase price today appreciates 3.1 percent to $257,750 in 2019.
If you would like to hear more about this topic, the market or how you can become a home owner, let us provide you with that information today!
Cassondra Liles, Real Estate Professional
919.351.5065 . | www.TheKeyTeam.com