How rising mortgage rates affect home-buying power

Interest rates on home mortgages are rising rapidly across the United States, which seems to be slowing most housing markets. (Some, like the market here in Corvallis, have been less affected. Give it time.)

The average mortgage rate for a 30-year loan was about 3.0% at the start of the year; today, it’s at 6.245% — even for somebody with an excellent credit score over 800.

Kim and I are fortunate that we bought our home in 2021 instead of waiting until 2022. Mortgage rates weren’t actually a factor during our deliberations last year; the historically low rates were simply an added bonus for buying when we did.

When we purchased our home last August, we took out a $480,000 mortgage at 2.625%. We didn’t hit the precise bottom of the mortgage market (that was early January 2021, when we might have had a loan for 2.5%), but we came close.

Here’s a chart from the Federal Reserve that shows mortgage rates from the past 2.5 years.

And here’s a chart that shows mortgage rates for the past 50+ years:

Mortgage rates have hovered at historic lows since the Great Recession of 2007-2009. And rates fell even further during the COVID pandemic. (These low rates are partly responsible for the blazing-hot housing market of the past two years.)

What do these rising mortgage rates mean to actual home buyers? Let’s use our situation as a representative example.

Rising Rates Decrease Buying Power

Last August, Kim and I closed on our home here in Corvallis. It’s a 1964 behemoth for which we paid $680,000. With a $200,000 down payment, we managed to get a 2.625% APR on a 30-year loan. We pay $1929.33 each month for principal and interest. (Our actual mortgage payment, including taxes and insurance, is $2528.43 per month.)

Today, that same loan would cost us 6.245%. If we wanted to buy this same house at the same price with the same down payment, our monthly payments for principal and interest would be $2956.04 — an increase of over $1000 per month compared to buying a year ago!

If we were shopping for homes today and wanted to keep our mortgage payment the same — $1929.33 per month — we’d have to lower our sights. Instead of taking out a $480,000 mortgage on a $680,000 home, we’d be looking at a $313,500 mortgage on a $513,500 home.

But wait! That’s not all! Home prices in our town have risen 10% during the past year, so that would further compromise our buying power. If we had waited until now to buy and wanted to keep our mortgage payment at $1929.33, we’d be shopping for homes that cost $467,000. Delaying a year would have decreased our buying power by $213,000 — over 30%.

While low mortgage rates didn’t spur us to move last year, they certainly gave us an incentive to act quickly. Conversely, if we had waited until this year, I’m not sure what we would have done. Knowing me and my aversion to onerous debt, I probably would have been reluctant to take out a mortgage. I would have tried to find a home to buy with cash, limiting my options even further.

When mortgage rates are at crazy lows like 2.625%, I don’t think twice about carrying a mortgage. It’s a no-brainer. I want a mortgage on my home every single time, and I never want to pay it off. A rate of 2.625% isn’t free money (and I don’t want to pretend that it is), but it’s pretty damn cheap. The gap between expected long-term stock returns (6.8%) and our mortgage rate (2.625%) is huge. There’s a lot of room there, a big margin for error.

On the other hand, there’s almost no gap between a rate of 6.245% and expected market returns of 6.8%. There’s no margin for error. I’m wary of borrowing money at this rate, especially such a large amount. I’d rather not have a mortgage with rates this high.

What Does the Future Hold?

I expect that rising interest rates will have their intended effect: They’ll cool the blazing-hot housing market. Will prices drop? Probably. But who knows? It’s clear, though, that a shift is coming.

I have a handful of friends who are real-estate agents. If you too have real-estate agent friends, then you know that they tend to be permabulls when it comes to their industry. They have an unflagging belief in the future of home prices. But even my real-estate friends believe some sort of shift has begun.

Here’s a long (and interesting) Facebook comment from one of my real-estate friends:

Last year, home prices were high, but those high prices were mitigated by super-low interest rates on home loans. Now you’ve got a double whammy: high prices and high rates. Today seems like an especially poor time to purchase a home. That’s not a good combo.

I feel sorry for folks who absolutely must move right now. They’re getting screwed.

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