yuck! Every time mortgage rates go up; buyers have to earn how much more to afford a house?
Among home buyers who thought 2022 would be their year, a pervasive sense of sinking is setting in. They realize that the monthly payment for a home they thought they could afford is now hundreds (if not thousands) of dollars more than they would have paid earlier this year. Their dream of buying a house is becoming more and more out of reach.
The reasons? Rapid rise in mortgage interest rates and inflation!
These higher rates have hurt the housing market, already manifesting in the high number of buyers who can no longer qualify for a mortgage. In turn, frustrated sellers reduce prices, but sales do not occur; therefore, home sales plummet and existing homes are on the market.
Most realized that rising mortgage rates would translate into higher monthly payments; but by how much? To give potential buyers a road map of what’s going on, mortgage experts have crunched the numbers to find out how much each increase in mortgage rates will affect buyers. How much will each percentage point increase the mortgage rate? And how much more do households need to earn to make monthly payments on a new home?
Higher mortgage rates affect affordability much more than most people realize. When interest rates are increased or reduced by 1%, purchasing power decreases or increases by about 12% according to mortgage experts. In January 2021, buyers were spending around 20% of their income to become owners, currently it is almost 40%, the highest since 1984.
To arrive at these results, the monthly mortgage payment for a median-priced home with a mortgage rate of 6.7% on a 30-year fixed loan was calculated. Payment includes tax and insurance and assumes buyers deposit 10%. The assumption is also that homebuyers spend no more than the recommended maximum of 30% of their gross income on housing.
Mortgage rates have more than doubled since the start of the year, rising from a low range of 3% to nearly 7% for 30-year fixed rate loans. That means buyers need a six-figure family income of around $124,000 to buy the home at the median price of $427,250 (September data) when just a year ago when rates were around 3%, buyers were expected to earn around $89,000. If rates rise to 8% (which many real estate experts are predicting), buyers will need an annual family income of $137,356 for a US home at the median price. At 10%, they would need to bring in close to $160,000 a year; meaning that the median-priced home would only be affordable to about 1 in 6 American households.
Economists say house prices are about 35% higher than current incomes should support. For the housing market to return to equilibrium, a combination of mortgage interest rate cuts, house price adjustments and higher incomes is needed, which could take years.
Rates could continue to rise, making it even more difficult for already stretched buyers. Some economists and mortgage specialists indicate that we could see 7.5 to 8%, in the next six to eight months; and most don’t see rates dropping any time soon.
This does not mean, however, that those who wish to buy houses will not be able to do so. Remember, even in the days of mortgage interest rates and teenage inflation during the Carter years; people were still buying and selling real estate because life events kept happening. People are getting married, divorcing, having babies, there are household deaths, job transfers, and/or health issues that require upsizing and/or downsizing. Life still happens in all sorts of real estate markets and housing is key; thus, the industry will find a way to meet the need.
Buyers trying to qualify for a loan find that increasing their down payments will reduce monthly payments, perhaps bringing in co-signers/co-buyers will help achieve these goals. Variable rate mortgages where the interest rate is lower for a set period of years at the start of the loan, then readjusts later, can help buyers get into their homes before prices inevitably rise.
Interest only, negative amortization and/or reverse mortgages are tools that could prove useful. Negotiating with sellers to provide credit to redeem the buyer’s interest rate is beneficial. Note: Inflationary pressures coupled with very low unemployment will drive up wages and salaries, meaning there should be some encouragement for homebuyers on the horizon.
The fix happens when buyers sit down with their trusted realtor and loan officer. Discuss requirements, location and mortgage/affordability options; so strategize! People who do this should still be able to make their home purchase work.