Effects of Rising Mortgage Interest Rates
How High Mortgage Interest Rates May Affect You
If you are conversant with the trend in the real estate market, you must have observed that the mortgage interest rates have been on the rise. The hike in the mortgage interest rates cuts across 30 year fixed rate mortgage, 15 year fixed rate mortgage and 5 year adjustable rate mortgage. While we are not here to debate the reasons for the hike in the mortgage interest rates, it will be a good idea for us to look at the possible impacts these may have on the real estate market players. So, the effect this may have on you will largely depend on the roles that you play in the market.
Impacts of Hike in Mortgage Interest Rates
Increased cost of borrowing: The immediate implication of the hike we current experience in the mortgage interest rates is the increase in the cost of borrowing. For existing borrowers of Adjustable Rate Mortgages, this is not a good time at all. There is tendency for the lender to increase their interest rates on both new and existing mortgages. This means that the amount that borrowers pay every month will increase. This may bring more pressure to their finance and this may affect their spending in other areas of consumption. For people who are already stressed out without an increase in income, some may even find it difficult to meet other obligations.
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Disincentive to young homebuyers: Home is one of the major investments that people make. People save towards the purchase of their home before they can say they are ready for it. Even though they intend to finance the home, they still need to make down payment. Subsequently, they need to be making their monthly payments every month. With the increase in the mortgage interest rates, some people who have based their budgets on lower interest rate initially may need to review their plans. Some may need to postpone the purchase of their home for now. For people who still want to buy their home despite the rising mortgage interest rates, they may not be clear on the type of mortgage to go for. Even through the interest rates seem to be high now, no one can tell whether this is just the beginning. If the interest rates will still continue to rise, this may be a good time to opt for fixed rate mortgage so that they can quickly lock in the current interest rate. On the other hand, if there is an indication that the mortgage interest rates will soon reverse, it may be better to wait for now. At best, going for Adjustable Rate Mortgage may be a good decision.
Incentive to Save: Because of the likely increase in the bank interest rates, many people will like to keep their money in deposit accounts for higher returns. However, the higher interest rates will only be beneficial to people that have money to save. For the borrowers, reverse will be the case. They will need to borrow at higher interest rates.
Reduced Consumption: For supermarkets and grocery stores, there may be fall in sales as people may cut down their consumptions. For instance, homeowners that are faced with higher interest payments may be forced to cut down their consumption as they will be left with reduced disposable income. Also, some people may defer some consumption so that they can have money to save as they will be motivated to save because of the attractive interest rate which means higher returns.
Fall in house prices: Any time the mortgage interest rates become too high, the mortgage becomes too expensive for prospective home buyers. This makes them to withdraw from taking mortgage. We understand the laws of demand and supply. If the supply in the real estate market is higher than demand, the house prices may start to fall. For this reason, it may make sense for new home buyers to be patient. Even if the mortgage interest rates do not come down, they may be compensated by the fall in the house prices. If house prices fall, it means that they may no longer require large amount of mortgage to finance their homes. They will have more money to pay as down payment and this will translate to paying less interest amount. For example, let’s assume that the price of a home is currently $220,000 and you need to make a 20% down payment. This will amount to $44,000. This means that you will need a mortgage loan of $176,000. For simplicity, I will leave out the closing costs. By the time I used Mortgage Payment Calculator using the mortgage interest rate of 4.56% for 30 year fixed rate mortgage, the cumulative interest on the loan was $147,298.58
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But let’s assume that the price of the same property later fall to $200,000 and you still have your initial money of $44,000 as down payment, you will only need a mortgage loan of $156,000. I will assume that the interest rate on the 30 year fixed rate mortgage has increased to 4.60%. The cumulative interest on the loan will be $131,901.08 as against $147,298.58 initially calculated. This is just a simple example to explain that increase in mortgage interest rates may not automatically translate to increase in interest payment. If you buy the property after the fall in the house prices, even though the interest rates have not fallen, you may end up paying less interest amount as the mortgage loan you will need may have dropped.