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The average rate for a 30-year fixed-rate mortgage has risen more than 2 percentage points in the first eight months of 2022, reaching a peak of 5.81% in June, according to Freddie Mac. After years of interest rates being at historical lows, this jump in rates is changing the math of buying a home. As rates climb toward 6%, homebuyers can expect higher monthly payments, less affordability and higher interest costs.
Here's how a 6% mortgage rate could impact your home search.
How Do Mortgage Rates Affect Monthly Mortgage Payments?
Higher mortgage rates mean higher monthly payments, but just how much higher depends on the size of your loan.
Using Experian's mortgage calculator, here's how monthly loan payments on a 30-year fixed-rate mortgage change, given a $400,000 home purchase with 20% down:
| Monthly Loan Payments from 3% to 6% | ||
|---|---|---|
| Interest Rate | Monthly Payment | Increase vs. 3% |
3% | $1,657.47 | N/A |
4% | $1,836.06 | $178.59 |
5% | $2,026.16 | $368.69 |
6% | $2,226.90 | $569.43 |
In this example, you're borrowing $320,000 and paying it off over 30 years, but at four different interest rates. At 6% interest, your monthly payment is $569.43 more than it would be if your interest rate was 3%. A $569.43 increase hits hard on your monthly budget, but also consider the additional total costs over a year: $6,833.16. Over the 30-year life of the loan, you'll pay $204,994.80 in additional interest, versus the same loan at 3%.
The range of 3% to 6% is hypothetical, but it's not far out of line with the way actual rates have changed in recent years. In January 2021, Freddie Mac reported an average interest rate of 2.65% on a 30-year fixed-rate mortgage. By August 2022, that same mortgage averaged 5.55%. Mortgage rates are fluctuating as the Fed raises interest rates to curb inflation. Whether the Fed will continue to raise rates—and to what extent—remains a matter of speculation.
How Does a Higher Mortgage Rate Hurt Home Affordability?
The higher your mortgage interest rate, the less home you can afford. Lenders consider your debt-to-income ratio (DTI) when deciding how much to approve on a mortgage. Your DTI is your monthly debt payments divided by your gross monthly income.
Requirements can vary from lender to lender, but typically a lender might look for a front-end DTI (how much of your monthly income goes to housing costs) of no more than 28% and a back-end DTI (how much of your monthly income goes to paying all your debts) of no more than 43%. Suppose you're applying for the loan in our earlier example and your gross monthly income is $7,500. Here are a few ways a lender might look at your DTI at 3% and 6%:
- Front-end DTI at 3%: $1,657.47 + $350 (property taxes and insurance), divided by $7,500 = 27%
- Back-end DTI at 3%: $1,657.47 + $350 (property taxes and insurance) + $200 credit card payments + $400 car loan, divided by $7,500 = 35%
- Front-end DTI at 6%: $2,226.90 + $350 (property taxes and insurance), divided by $7,500 = 34%
- Back-end DTI at 6%: $2,226.90 + $350 (property taxes and insurance) + $200 credit card payments + $400 car loan, divided by $7,500 = 42%
At a 3% interest rate, a front-end DTI of 27% and a back-end DTI of 35% both look good. But at 6%, back-end DTI (42%) is borderline and front-end DTI at 34% may be too high for this loan to be approved. The higher interest rate in this example turns an affordable loan into an unaffordable one—and decreases the chances of getting the loan.
Can You Lower Your Mortgage Payment to Make It Affordable?
A lower mortgage payment might improve your odds of being approved for a loan, even at a higher interest rate. Although the following ideas might not work for every situation, here are a few ways you might adjust your options:
- Increase your down payment. You'll lower your mortgage amount and, with it, your monthly mortgage payment.
- Get a longer loan. Financing $320,000 over 40 years lowers your mortgage payment by $466.20 per month. This, however, will result in paying far more in interest over the life of your loan.
- Consider an adjustable-rate mortgage (ARM). An ARM may have a lower starting rate than a 30-year fixed but read the fine print to understand the difference between the two loans.
- Raise your credit. If a low credit score is keeping you from being approved for a better mortgage rate, working on your score could help.
- Lower your home price. In a more competitive market, home sellers may be more inclined to accept a low offer. Alternatively, consider shopping for a less expensive home to keep your mortgage and monthly payment low.
Are Mortgage Rates Expected to Climb?
In late August 2022, rates on 30-year mortgages were down from their peak in late June, according to Freddie Mac. While signals from the Fed—and speculation among economists—seems to change daily, getting inflation under control has proven to be difficult. The Fed may raise interest rates again in 2022, or at least hold strong on current rates through the end of the year.
Some economists think mortgage rates may drop in 2023 if aggressive rate hikes slow the economy dramatically. Housing prices may also soften as mortgages become less affordable. Unfortunately, there's no way to know exactly how these factors will play out. If you're thinking about buying a home or refinancing your mortgage now, your best strategy might be to consider how much mortgage you can afford at current rates and decide whether you can live with the available options.
The Bottom Line
Rising interest rates and economic uncertainty can make this a challenging time to finance a home. Working with a lender or mortgage broker on preapproval might help: You'll find out exactly how much mortgage you qualify for and how much your monthly payment will be before you commit to a home purchase. You may be able to lock in a rate as well, which could be beneficial if rates go up.
This is also a prime time to check and monitor your credit. You can get your Experian credit report and credit score for free from Experian. Also consider free credit monitoring to receive alerts when your credit score changes or new information appears on your credit report. Interest rates on mortgages may continue to fluctuate over the next several months and beyond. By maintaining your best credit, you'll be positioned to secure the lowest available rates on a home loan now or whenever works best for you.