When interest rates increase, your buying power decreases. The general rule is that for every 1% increase in interest rates, your buyer power decreases by 10%.
As the interest rate goes up, you will pay more in interest each month and have less in each payment to pay the original loan. The result is less purchasing power.
A typical mortgage payment is made up of two parts:
The principal payment that pays down the original loan
The interest amount that pays the lender
A lender will review your financial health, including your income and debt levels to determine how large of a mortgage payment you can realistically afford to pay each month. Essentially, as interest takes up a larger portion of your monthly payment, there is less available to pay down the original loan amount, which decreases how much a lender will loan you.
A higher interest rate also means you will spend more money on interest over the life of the loan, resulting in you paying more money for the house overall.
EXAMPLE
Assume you are able to carry a mortgage payment of $2,000 per month and the lender is charging 2% interest. In a typical mortgage loan, the lender would provide $472,000 and with 20% down you would have $590,000 available for the purchase price of the home.
Now let's keep everything the same except the interest rate increases to 3%. The lender would now provide $422,400 and with 20% down you would have $528,000 available for the purchase of your next home.
The total budget available for your next home purchase decreased from $590,000 to $422,400. This is a $67,600 reduction or 12.9% decrease in purchasing power.
Note: The example provided uses a 25 year amortization period and assumes a 20% deposit.
Review
As a buyer it is important to be aware of changing interest rates as these impact how much you have available to purchase your next home and how much money you will pay in total interest over the mortgage term. As interest rates increase, buyers will have less capital available to purchase homes through mortgage loans. The general rule of thumb is that for every 1% increase in interest rates, a buyer will have 10% less purchasing power.
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