What Happens When Mortgage Rates Rise?
Mortgage rates are one of the key factors deciding the purchasing power of general population and the costs of real estate. Even a small fluctuation in the mortgage rates can cause a drastic change in the buying power for the buyer looking to get qualified for a loan.
On an average a 1% increase in mortgage rates causes 12% decrease in the buying power.
If a person can afford a $200,000 loan on 3.75% interest rate, on 4.75% they would only be able to get $177,000 mortgage if the monthly installments are kept the same. This can be seen from the example that the effect of a small rise in the rates is drastic on the affordability of a person.
As an actual example, the current 30 years fixed mortgage rates in the US are 3.85%. There were higher mortgage interest rates last year. The decrease has caused a 4.24% increase in the buying power. Likewise if the rates increase the buying power will surely decrease.
It means that if you are planning to purchase a property on mortgage, you will be able to buy “less home” or real estate after the rates rise. But it does not mean you will not be able to buy a specific home. This is a complex game. As the mortgage rates go up, not only does it mean that the purchasing power will decrease but it also means that the real estate prices will fall. There is a simple logic behind it. As the mortgage rates rise, lesser people would be able to qualify for the mortgage and even those who qualify will have to think twice as they will have to make larger payments. This is just a simple case of demand and supply imbalance. The demand decreases, the price decreases.
But the financial market and specially the mortgage market is not always that simple. It is a complex dynamic system governed by a number of factors. With the increase in globalization, the economy is also shifting from a local to global economy. The factors like inflation expectation and economic growth. These factors combine to affect the rates of real estate. The rate hike may or may not cause a change in the values of real estate but the effect on the purchasing power is a more obvious one.
Buyers and lenders are constantly controlling one another. The lenders know that every buyer can pay a certain maximum value for a specific property. This depends on the down payment they can make and the monthly installment they can afford. On the other hand the seller is always seeking the highest amount they can get for their property.
As the interest rate on mortgage loans rises the interest proportion in the loan rises. This is another factor which can decrease the rates of real estate. The buyers generally think they have to pay much higher price other than the actual amount they borrowed (Principal) this thinking can abstain some people from purchasing real estate hence the decrease in demand will decrease the rates.