Home Affordability is limited by income, other debt payments, and the mortgage payment, which comprise debt-to-income ratios. Typically, mortgage loan programs accept a maximum debt-to-income ratio of between 43 & 53 percent. Since the loan amount, loan amortization, and rate determine a mortgage’s monthly payment, as rates go up, affordability goes down.
As a rough estimate, as rates go up, the maximum loan amount a client can afford is reduced. Here is the factor, for each .25% of increase in rate, the amount that a client can finance is reduced by 2.5%.
A client inquires as to how much she can afford to buy. Her mortgage company replies that her maximum purchase price is $485,000 with a loan amount is $400,000 at a rate of 4.0% for 30 years fixed, so she begins thinking about buying a home. She will need to bring in approximately $100,000 down payment & closing costs. A year later, she decides to get more serious about shopping for a home and finds a home for $485,000. But, since she waited and rates have gone up to 4.5%, her maximum loan amount is 5% less, or $380,000. So, she will need to bring in $20,000 more to closing than she had planned or find a home that costs about 5% less.
The Freddie Mac chart above shows the interest rates from 2007 to 2018. Rates since 2018 have remained fairly stable at approximately 4% which is <1% above historical lows and 2% below rates from 10 years ago.
Often, rising interest rates also come with rising home prices, further exacerbating the affordability issue. While no one can predict rates and home prices with certainty, rates are near record lows with much more room to rise than fall and home prices over the long term.