2017 is nearly upon. T-minus 3 days and counting. What new surprises and adventures still await us? We have yet to see. One thing is for sure: mortgage rates are slowly ticking upwards.
But so what. Rates are at historic lows still. Who cares if the go up a point or two. That doesn’t really have a major effect on anyone, right?
Wrong. Rising interest rates have a major effect on the economy as a whole. In one sense, it’s good. It means the economy is doing well. Better than expected by the government bureaucrats. In fact, it’s doing too well. It’s growing to fast. And the only way to slow down (or control) the growth is to raise interest rates.
Here’s a 5 second economy lesson. Raising interest rates makes it more expensive to borrow money. Which means people will borrow less. That means they will spend less money, which in turn slows down the economy.
“Alright geek, what does that mean to me,“ you ask? Simple. It costs more to borrow less.
When buying a house the interest rate determines how much house you can afford (next to your income.)
Take the following example. A loan applicant — we’ll call him Steve — has a monthly gross income of $5,000 and expected total monthly debt of $2,250. His debt-to-income ratio (monthly income divided by the total amount of monthly debt payments) is 45% in each scenario.
|Rate||Payment||Max Price||Buying Power Difference|
This means if Steve can afford to buy a $380,000 house in 2016, if interest rates rise only 1% in 2017, he is now only able to buy a $345,000 house. Waiting 1 year to buy a house cost him $35,000.
The moral of the story: as interest rates rise, your buying power decreases significantly. Rising rates can hurt buying power even more than increasing home prices.