Angeline Combs Unlock Technologies Staff Writer
If you are a homebuyer, your mortgage interest rate directly affects your monthly payment. It also impacts how much your loan will cost in the long run. This year, the Federal Reserve has raised interest rates several times making the cost of buying a home more expensive. If you are a house hunter, it’s important to understand how even 1% of an increase in your interest rate can cost in your monthly mortgage payment.
Let’s take a look.
Your mortgage includes more than just the interest and principal of what you borrowed to pay for your home. Typically, your mortgage will include an escrow account. This means your monthly payment includes a portion set aside each to pay property taxes and homeowners insurance.
It's good to have that escrow account because you don’t have to worry about forgetting to pay your property taxes or having a big bill due at one time. Homeowners insurance is obviously very important to protect your new asset.
A mortgage requires a down payment. The more you put down, the less you will pay each month. Most mortgages require a 20% down payment but not all do. For instance, if you qualify for an FHA mortgage you could put down as little as 3.5%. However, this means you could be stuck with private mortgage insurance (PMI) to offset the potential risk to your lender in case of a default. It’s always better to put more money down and avoid PMI if you can afford to do so.
Right now, the biggest challenge in affordability for a home is the cost of financing. Your interest rate is factored into your monthly mortgage payment. Your credit score is also a consideration. Due to the recent hikes in rates from the Federal Reserve, even a perfect credit score can’t guarantee a low rate. If you choose 15 or 20 -year term, you could get a more favorable rate than say a 30 year, but that payment could be unaffordable.
Here’s an example: let’s say you purchased a home in 2021 for $300,000 and you received a 3.5% fixed interest rate. Your monthly payment would be approximately $1,655 and you’d end up paying a total of about $484,968 in principal and interest.
Now let’s compare. You just purchased a home in 2022 for $300,000 and rates have jumped 2% so your rate is now 5.51%. This may not seem like a big deal until you calculate how much this changes your payment. That $1,655 monthly now would cost you approximately $2,013 per month. And the loan is going to cost about $613,889 in principal and interest when you pay it off.
We can’t control what the Fed is going to do and how high interest rates will ultimately rise. You can take these steps if you are determined to buy a home right now.
Consider your overall budget. Do your best to budget a maximum of 30% of your income for housing costs.
Find a lender you trust. do your research to compare their rates with other competitors. Talk about a monthly mortgage payment that feels comfortable in your budget.
Consider a larger down payment and shorter term. If you can afford to put more money down, or finance a shorter mortgage such as a 15-year , you can dramatically save money on your mortgage overall. A larger down payment can help you avoid PMI or reduce your monthly payment. A 15-year-term yields about a 4.95% interest rate rather than 5.95% for a 30-year. Understanding interest rate hard costs is important as you consider your budget.
You do not have to cancel your homebuying plan, but being strategic and smart will set the stage for achieving your goal.