How Do Higher Rates Affect Qualifying? Potentially A Lot.

house-sky-palm-treesRATES ARE GOING UP, REST ASSURED

We’ve said that at least a hundred times over the years but this time it is a reality b/c the Fed is no longer buying bonds to push rates down, and b/c the Fed is very determined to push rates up in general.

We saw a slight dip in rates recently largely b/c of economic turmoil in Italy, but rates are expected to climb another 1/2 percent this year alone.

HOW WILL RATE INCREASES AFFECT THE QUALIFICATIONS OF A PRE-APPROVED BORROWER?

Rule of thumb: A 1/2 percent increase in rate will increase a mortgage payment by about $30 for every $100,000 borrowed.

Hence, if a buyer is looking at a $600,000 mortgage, her payment will increase by about $180 if rates go up 1/2 percent.

In regard to qualifying, an increase in rate could easily shave off $25,000 to $50,000 from a buyer’s maximum.

For example, let’s say “Bob” the buyer is pre-approved for a maximum $750,000 purchase with 20% down at rate of 4.75%.

Let’s also assume Bob’s maximum payment (Principal, Interest, Taxes, Insurance) is $4,000 and his income is $8,900 per month, giving him a maximum debt ratio of just under 45% (all numbers are rounded).

If rates increase 1/2 percent, Bob’s maximum qualification would drop to about $715,000 b/c that is the most Bob could buy in the higher rate environment without pushing his payment over his $4,000 limit.

In other words, if Bob’s rate increases from 4.75% to 5.25%, Bob will lose about $35,000 of purchasing power.

What can poor Bob do?

A. Consider an Adjustable Rate Mortgage (ARM). Bob can knock as much as 1/2 percent off of his rate by considering a 7/1 ARM. Knowing that very few buyers ever keep their mortgages more than 7 years will help Bob rest easy with his ARM.

B. Buy now while the getting is good! If Bob is hellbent on a 30-year fixed rate loan, he should buy now to lock in today’s rates. BUT – we will still remind Bob that even if rates are in the mid-5’s, they are STILL a “gift” by historical standards.

C. Buy a $50 tent and a motorcycle, and skip the house thing. I did that in my early twenties, and it was really fun. Bob might want to do the same. But don’t worry, we won’t suggest it.

Lastly – should Bob worry that higher rates might hurt home prices?

According to this blog, no 😊.

Jay Voorhees at (925) 855-4491
Real Estate Broker, CA Bureau of Real Estate, BRE# 01524255, NMLS# 335646