In mid-December 2015, as predicted, the Federal Reserve raised its key interest rate by 25 basis points and mortgage loan interest rates are expected to rise slowly throughout 2016.
There is no question that first-time buyers will be the group most affected by increased mortgage interest rates. Here are insights you can use if you’re a first-time homebuyer in Minnesota or western Wisconsin.
How affordability works
As interest rates increase, the buying power of a borrower is lessened. Let’s say a homebuyer has $1,200 to spend on their monthly mortgage payment. If rates are 4 percent and the borrower secures a 30-year fixed conforming loan, their loan could total around $250,000. The monthly mortgage payment in these conditions would be $1,194.
Now let’s say rates rise 1 percentage point to 5 percent. With all the mortgage terms remaining equal, the borrower would pay $1,208 monthly for a loan totaling $225,000. That’s a difference of $25,000, or 10 percent, in buying power.
This matches the sentiments of lending experts who agree that if current rates increased 1 percentage point, buyers would lose 10 percent of their purchasing power.
Why first-time buyers will be affected most
Many first-time buyers do not have a large down payment, and government and private lenders have changed their standards in order to accommodate these high earners with minimal savings. FHA loans can now be secured for as little as 3.5 percent down, while conventional (private) loans have a minimum of 3 percent down.
While these new minimums have prompted many first-time buyers to enter the market, it also means these buyers are relying heavily on financing. In fact, first-time buyers financed nearly 94 percent of their home purchase in 2015 – meaning that on average, these buyers had saved an average of 6 percent for their down payment.
If rates were to rise 1 percentage point, most first-time buyers would not be able to increase their down payment to make up the 10 percent difference in affordability. If rates increase, their only choice will be to lower their home buying budget.
The silver lining
It’s easy to be frustrated by the predictions of rising rates, but the reality is that our local market is still a great place to buy. Keep in mind that:
- Buyers are still in control of their purchasing power. Here are a few ways to ensure you get the best rate as a first-time buyer.
- Once you put your mind to it, saving a down payment can be achieved relatively quickly by many. According to the NAR, 63 percent of first-time buyers say it took them less than 18 months to save a down payment.
- While personal savings is still the most common way to finance a down payment, many first-time homebuyers are taking advantage of gift funds from friends or relatives.
- First-time buyers can also apply for down payment assistance on many homes in our area, which can offset the stress of a rate increase.
- Even if mortgage interest rates increase to 5 percent, that is still very low compared to historic highs of 16.63 percent in 1981.
Getting ready to buy
Prepping to buy your first home is an exciting time and getting pre-approved is the best step you can take to start the process. A pre-approval will tell you the loan amount you will qualify for, allowing you to set a responsible budget (and expectations) as you begin looking at properties online and in person.
Don’t forget to look at #BuyerInsights on Twitter, Facebook, Instagram and YouTube for more insights you can use to navigate the first-time home buying process.