If spending more time at home lately has you wishing for extra elbow room, a different floor plan, a bigger kitchen, or any other particular housing feature, you’re not alone. Many Americans are looking into the possibility of purchasing homes that have room for a home office; others long for a back yard, a home gym, or a fresh start. While aspiring homebuyers may have different motivations, they do share a common advantage thanks to today’s historically low interest rates: increased buying power.
How Low Interest Rates Affect the Cost of Homes and Buying Power
Most would-be homebuyers quickly learn that a low interest rate is highly desirable. Yes, your interest rate affects the total amount that you’ll ultimately pay for your home purchase. However, it also has a more immediate impact on your purchasing power.
Interest Rates and the Cost of Buying a Home
Mortgage interest is the amount a lender charges for the chance to use a loan to purchase a residential property. Simply put, it’s the cost of taking out a loan. As Investopedia explains, interest is expressed as a percentage of the loan amount, which is typically referred to as the interest rate. With a higher rate, you’ll pay more interest over the life of your loan, which increases the total cost of your home purchase. On the other hand, securing a lower interest rate will reduce the cost of borrowing and the total amount of interest that you’ll pay, enabling you to pay less for your home.
Interest Rates and Purchasing Power
Buying power, or purchasing power, refers to your ability to get value for your money. How do interest rates impact that? With a home loan, the cost of paying interest is factored into your monthly mortgage payment, and it can have a major effect on your housing budget.
Imagine two homebuyers are purchasing homes with identical price tags. Buyer A has a higher interest rate, so they’ll need to pay more interest, and their monthly mortgage payment will be more expensive. Buyer B snags a lower interest rate, so they’ll owe less interest and see the savings in their monthly mortgage payment.
Now, imagine the two homebuyers are still searching for the perfect home, but they are intent on paying the same amount for their monthly mortgage payment. Because buyer A will be paying more interest, they’ll have less to spend on the actual house. Meanwhile, buyer B will be able to get more house for the same monthly payment.
How much of a difference will varying interest rates make? According to My Mortgage Insider, a one-percent rise in your interest rate will reduce your buying power by more than ten percent.
The Difference a Point Can Make
How much of a difference does a point make? According to a recent report from Redfin, a buyer who paid $457,000 for a home in March 2019 when interest rates were 4.4 percent would have a monthly payment of $2,500. A buyer who purchased the same home for the same price in March 2020 when interest rates were 3.2 percent would have a monthly payment of $2,250. That’s a savings of $250 a month and $3000 a year!
Looking at it another way, a buyer willing to pay $2,500 a month in March 2019 would be able to buy a home priced at $457,000. In 2020, the lower interest rates would boost their purchasing power significantly. That same payment would allow them to afford a home priced at $508,250.
The Hidden Challenge of Low Interest Rates
Low interest rates deliver clear benefits. They reduce the total cost of borrowing and increase a buyer’s purchasing power by making higher-priced homes available for lower monthly payments. However, they may also trigger a hidden challenge. As The New York Times notes, the appeal of buying now may increase competition among prospective homebuyers. This can reduce the stock of available homes and drive up the prices of those on the market.
What do your housing goals look like? Whether you’re eager to leave renting behind by purchasing your first home, interested in buying a bigger home with more amenities, or intrigued by the notion of investing in a second home, PrimeLending of Denver can help. Contact us today to learn more about our services and how they can benefit you.