How Home Loan Interest Rates Impact Buyers And Sellers

Paying a mortgage is one of the most fundamental aspects of home ownership, and changes in home loan interest rates impact both buyers and sellers. Whether you are looking to purchase a home in the near future, or a homeowner thinking about selling, understanding the effects of home loan interest rates for both parties in a real estate transaction is important. This article will break down what changes home loan interest rates mean for buyers and sellers, and property values overall. First, it’s essential to understand the state of home loan interest rates in today’s market.

What are Home Loan Interest Rates Like Today?

For the past decade, mortgages in the U.S. have been at an all time low. As of January 19th, interest rates on 30-year fixed-rate mortgages experienced a dip for the third week in row. They are currently at their lowest levels since the beginning of December.

Sitting at lower than 4% all year, the average rate for a 30-year mortgage was bordering on a record low. But as of last month, the average rate for the same type of mortgage reached 4.3%. A rate of this percentage hadn’t occurred since April 2014.

Even despite the jump, it’s important to remember that home loan interest rates are still quite low when compared to previous decades. In the 1980s, for example, they seldom fell below 10%. But regardless of the historical comparison, home loan interest rates today are still the highest they have been in over two and a half years.

Why the Increase in Home Loan Interest Rates?

In December 2016, the Federal Reserve increased its interest rate, impacting the amount of money that banks are able to lend one another overnight. This in turn has a ripple effect on home loan interest rates. If banks are being charged a higher interest rate to lend money between themselves, it will impact the interest rate that they then charge to their customers. Credit card rates, home equity and lines of credit are immediately affected – and while mortgages aren’t impacted right away, they are typically quick to follow.

Mortgage lenders determine interest rates based on what they anticipate in future with regards to inflation and changes in the Federal Reserve’s interest rates. Additionally, the supply and demand of mortgage-backed securities also plays a role in home loan interest rates.

It essentially boils down to sharing the interest rate increase amongst all the parties involved. While it may not be a direct correlation, there will be a slight domino effect on mortgage rates from the rise of the interest rate of the Federal Reserve.

What Does it Mean for Homebuyers?

The lower that home loan interest rates are, the more spending power potential buyers have to purchase a home. Paying less interest means buyers can consider homes that they may not have otherwise been able to afford. While there are numerous other factors involved, the outcome of lower interest rates and more potential buyers is that the price of property usually goes up. This is caused by a greater demand from home buyers. As demand increases, usually home prices follow. In fact, one of the main reasons for the increase in home values over the past four to five years in Silicon Valley and throughout the country is due to low home loan interest rates.

The opposite is also true. When home loan interest rates rise, mortgage payments become higher, reducing the spending power of buyers. Property prices can drop, because there are less buyers looking, and supply (the number of homes for sale) is potentially greater than demand.

What Does This Look Like in Actual Dollars?

Toward the end of October 2016, the rate of a 30-year fixed mortgage was 3.47%. Compare this to today’s 4.3%, and it’s there’s a noteworthy spike in monthly mortgage payments.

Assume you purchased a home for $268,000, which was the median home price in the United States in October, and made a 20% down payment. An average monthly mortgage payment would be $1,280, at a home loan interest rate of 3.47%. But by December, just a few months later, the rate rose to 4.16%. The same mortgage payment thus increases by $86 per month to $1,366. It would be even higher with today’s rate of 4.3%.

In Silicon Valley, a single-family residence may sell at $1,300,000. With a 20% downpayment, that would lead to a $1,040,000 mortgage. At an interest rate of 3.47% would equate to a monthly payment $5,175.96. But with an interest rate increase up to 4.16%, the monthly mortgage payment suddenly jumps to $5,561.19. The interest rate increase results in an extra $385 that must be put toward a mortgage payment each month.

Changes in interest rates can result in noticeable differences in monthly home loan payments

What do lenders look for in qualifying a buyer?

When deciding whether to approve a prospective homebuyer for a loan, a financial institution always considers the “Three C’s”:

  • Collateral
  • Credit
  • Capacity

Collateral refers the down payment that the potential client is able to make. Credit refers to their credit scores, and capacity to their debt-to-income ratios.

Capacity (the ratio of the prospective homebuyer’s debt to their income) is what is affected by home loan interest rates.

Debt-to-income ratio is a formula that banks use to make sure that a buyer can repay their loan. First, they take into consideration that person’s total monthly debt. This includes the potential new mortgage payment, principal, interest, property taxes and insurance, and all the minimum payments that show up on the person’s credit report. Then, the bank will divide this amount by the person’s gross monthly income. Most lenders will allow for a maximum 45% debt to income ratio. If a potential buyer’s debt to income ratio is greater than 45%, the bank will not approve them.

What does this have to do with home loan interest rates? The higher these are, the higher the monthly mortgage payments are. The higher the monthly mortgage payments are, the greater the amount of debt to calculate when figuring out a potential buyer’s debt to income ratio. This subsequently impacts their chances of getting an approval for a loan.

Sometimes potential buyers will be very close to the maximum percentage allowed for the debt to income ratio. If the home loan interest rates increase, they may have to look at lower priced homes.

What Does it Mean for Sellers?

It’s not just buyers feeling the effects of changes in home loan interest rates. Sellers will also feel the impacts of these fluctuations.

When home loan interest rates rise, buyers can immediately qualify for a lesser amount than they would have before if their debt to income ratio is close to the maximum allowable percentage. This means they have less spending power. With less spending power in the hands of buyers, there can be less of a demand for properties. What may have been a feasible option for a buyer before the increase in rates will suddenly become unaffordable.

For the seller, this can mean less demand for their particular property. This is because a fewer number of buyers are able to actively look for a home, and maybe more importantly, get approved for their asking price. With less demand, the only way for a homeowner to improve the likelihood of selling their property may have to be a decrease in price.

What’s the Current Home Loan Interest Rate Situation Like for Sellers?

Economists speculate that the Federal Reserve will raise rates three times in 2017. This will lead to a rate of 1.4% by the end of the year. Last December marked the second time that the Federal Reserve raised interest rates in a decade. The impact is already noticeable.

Since many economists predict and expect rates to rise, this could mean a slow down for the housing market. This is especially true in high priced areas like Silicon Valley. Higher home loan interest rates mean that buyers aren’t able to exercise as much spending power. This leads to the potential for lower demand for property purchases.

To Sell, or Not to Sell?

If you are considering selling your property in the next little while, now may be the time to do so.

Predictions show that rates will increase in 2017 more than in the past several years. Property values are already at all time highs, and Silicon Valley contains some of highest priced real estate in the country. This means that higher home loan interest rates will make many already high value homes out of reach for prospective buyers who may have been able to afford them a few months ago. If this is the case, then sellers will experience less demand for their home, meaning they will likely need to consider reducing their listing price.

The pros of selling soon could very well outweigh the cons of waiting. Although nobody can predict what the future holds, it may be possible to obtain a higher sales price for your property now than later in the year. With a seasoned agent, customized marketing plan, and a 1.5% listing fee, it’s possible to generate an even higher sales price for your home, while putting more money in your pocket. A digital brokerage will reach a greater number of potential buyers compared to a brokerage or agent who advertises in print or applies the minimum when advertising a home for sale.

By using the SoldNest Home Sale Calculator, it’s easy to find out the potential amount you could net on the sale of your home in a few quick steps.

The Bottom Line

Changes in mortgage rates impact both buyers and sellers. For buyers, increased rates mean less spending power and a higher monthly mortgage payment than they may have otherwise anticipated. Lower rates allow for an opportunity to consider more property options.

For sellers, increased rates mean fewer people that are able to afford their particular property. Lower rates mean an increased demand and the possibility of setting a higher listing price for their home.

Whether you’re buying or selling, understanding home loan interest rates is important to making an informed decision in any real estate transaction. With rates set to increase over the coming months, now might just be the best possible time to put your home on the market.

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