So, let’s say that you qualify for a Principal & Interest (P&I) monthly payment of $1,200 (using only P & I to illustrate – taxes, homeowner’s insurance and mortgage insurance are not included).
- Sales Price of $295,000
- $1,200 per month
- 30-year fixed rate
- 20 percent down payment
- Loan amount of $236,000
- 4.5% interest rate
So, what happens with a 1% increase in interest rate?
Same scenario — but the rate is now 5.5%. The maximum sales price decreases to $265,000. With 20% down payment, the loan amount is now $216,000 or a 10% decrease in purchasing power.
This chart shows you how a .5% or one-half percent interest rate increase affects a home buyer’s purchasing power.
(NOTE: Monthly payments have been rounded up or down by a few dollars. APR’s are not disclosed. Chart for illustration purposes only.)
For every 1 percent interest rate increase, your purchasing power may be decreased by 9 to 11 percent (the percentage is smaller for lower loan amounts).
While no one can tell you exactly when and by how much there will be an increase in interest rate, the chart above gives you an idea of how it may affect how much you will qualify for when buying a home.
Before you start looking at properties, you should get pre-approved for a mortgage. This lets you know approximately how much you are allowed to borrow for your mortgage, specifies the terms of your mortgage, and it allows you to have some of the paperwork already in place when you do find a home that you love. It gives you an idea of the price range of homes you should see; just think of how frustrating it would be to fall in love with a home and then discover that you cannot afford it. Lastly, to sellers, it will demonstrate how serious you are about buying.
Remember that being pre-approved isn’t actually getting a mortgage, but simply what you can expect when the time comes to get one.
Calculate Your Budget
Getting pre-approved for a mortgage lets you know that maximum amount that you can borrow for your mortgage. However, this isn’t necessarily the amount you want to spend on a home. You need to factor in your down payment, interest on your loan, property taxes, renovations, routine maintenance, moving expenses and other costs related to the home purchase. Do you want some new furniture, plant some flowers, or buy a patio set? You need to set aside additional funds for all of these costs. And don’t forget that you need to save for retirement, go on a vacation, and have an emergency fund too. Therefore, before you go home shopping, calculate how much you can, and want to, spend on a home after deducting all of the other necessary expenses.