Up, Up, and Higher They Will Go

Interest rates are low. In fact, they are really low. When interest rates are going to rise is the topic of Wall Street and Main Street. If it is going to happen is not the question, but rather when. Janet Yellen (GO BEARS!) is going to raise rates. How fast and when though is still on the horizon.
As potential homebuyers hear that rates are going to rise, and sellers hear the same, how is the market going to react? Let’s take a look at buyers for this newsletter (number heavy).
Below are 5 different interest rates and the corresponding monthly payments on a $100,000 mortgage. For those looking at $1MM mortgages, just multiply the payment by x10 and that will give you a good representation of the payment (the same goes for any other mortgage amount – just divide the mortgage amount by $100,000 and multiply by the payment below). You can also set your own interest rates, mortgage amounts, mortgage term, etc. here.
The first rate increase will not be too drastic, so we are going to assume a .25% increase. What does this mean to the typical mortgage payment (the correlation between the 10-year Treasury and the 30-year fixed rate mortgage is pretty strong so are underlying analysis assumes each Fed increase will increase the 30-year fixed rate mortgage by the same amount)?

Mortgage Amount: $100,000
Mortgage Terms: 360 months (30-year fixed)
Today’s Interest Rate: 4.25%
Monthly Payment (Principal and Interest): $491.94
Mortgage Amount: $100,000
Mortgage Terms: 360 months (30-year fixed)
Interest Rate: 4.50%
Monthly Payment (Principal and Interest): $506.69
Mortgage Amount: $100,000
Mortgage Terms: 360 months (30-year fixed)
Interest Rate: 5.00%
Monthly Payment (Principal and Interest): $536.82
Mortgage Amount: $100,000
Mortgage Terms: 360 months (30-year fixed)
Interest Rate: 10.00%
Monthly Payment (Principal and Interest): $877.57
From above, a change of 0.75% (or from today’s current rate of 4.25% to 5.0%), your monthly payment per $100,000 mortgage would go up by $44.88.
Now to loans. For any manually underwritten loan, Fannie Mae’s maximum total debt-to-income (DTI) ratio is 36% of the borrower’s stable monthly income. The maximum can be exceeded up to 45% if the borrower meets the credit score and reserve requirements (and even up to 50% for certain loan case files with strong compensating factors).
We are going to use an income of $100,000 in our example to make things easy. At 36% DTI, you can afford a monthly payment of $3,000 (if you want to figure out your DTI ratio, take your annual income and divide it by 12 and then multiply the amount by the ratio you want to use i.e. 36%). In this example (again there are factors we are leaving out, such as taxes and insurance, mortgage insurance if necessary, etc.), our homebuyer just went from being able to afford a $609K house to $558K (about 91.6% of what they could buy before the rate increase). Assuming we do not go back to the 15+% mortgage rates of the early 80’s, the reduction in purchase price from interest rate increases should not drastically change buyers’ behavior.
So for those frantically looking to “lock-in” the lowest rates of, well almost ever, do not worry too much. Likely you are going to be just fine waiting until you find the right property you are looking for. You can also offset the reduction with an increased down payment from saving, or looking for a property that you can put some “sweat equity” into (despite SF teardowns still collecting top dollar).
For sellers, do not fear an interest rate rise. I will go into the effects of a rise in greater detail on an upcoming newsletter, but for now know that if there is an interest rate rise and you sell, you might be able to get more than 1% on your money if you put it into a Bank CD/AAA Corporate Bond.

If you ever have any questions at all, please do not hesitate to reach out. At MinnGo, we realize that real estate is not something our clients think about everyday. Lucky for you, that is what we live and breath.

Until next time.