The Impact of Rising Mortgage Rates

Mortgage rates will be starting to rise from this week on.  From the 3.9 to 4.0 percent average rate in the past five months on a 30-year fixed mortgage, the new rates will soon be in the range of 4.3 to 4.6 percent.  Usually the initial phase of rising rates can quicken the decision to sign on the dotted line as consumers do not want to face even higher mortgage rates later on.  However, a prolonged increase will shrink the pool of eligible home buyers.

Here are some raw statistics to contend with.  Let’s say a person is committed to paying at most $1,000 per month in principal and interest to be comfortably within this person’s budget.  A mortgage calculator will spit out that at a 3.9 percent rate (last week’s rate), this homebuyer will be able to take out $212,000 in mortgage amount.  At 4.5 percent (near future rate), the figure drops to $198,000, or the equivalent to a drop of 7 percent in purchasing power.  The homebuyer therefore has to shoot for lower price points.

Another way to view the impact of rising rates is to compute the income required to get the $212,000 in mortgage funds as in the above example.  At 3.9 percent, the income would have to be $4,000 per month, assuming that this particular person only feels comfortable with a mortgage payment taking up 25 percent of his or her income.  At 4.5 percent, the mortgage payment to buy that same home would be $1,074 per month and the corresponding monthly income requirement would be $4,296.  Now, how many people have a monthly income between $4,000 and $4,296 or on an annual basis between $48,000 and $51,552?  According to the Census income distribution table, 2.9 percent of the population is between these two incomes.  This income gap also represents how many people would have qualified to buy this particular example home before and after the mortgage rate change.

Simply put, if mortgage rates rise to around 4.5 percent in the upcoming weeks from the previous 3.9 percent, then home sales are expected to be impacted by 3 percent.  If the 30-year fixed mortgage rate rises to 5 percent then the impact is closer to 6 percent.

This illustration is what economists call a static analysis.  It assumes that other variables are not changing.  In the real world, the confluence of factors makes the data analysis less clean.  The 3 percent impact may not be meaningful if, say, job gains pick up steam or mortgage underwriting standards become less restrictive.  Then there are the cash buyers, making up about one-third of all buyers in the past year, who would care squat about rate changes. Still, it is worth keeping in mind that rising rates will put some drag on the broader housing market recovery.

Lawrence Yun, PhD., Chief Economist and Senior Vice President

Lawrence Yun is Chief Economist and Senior Vice President of Research at NAR. He directs research activity for the association and regularly provides commentary on real estate market trends for its 1 million REALTOR® members.

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  1. Great article. People have become so accustomed to low rates that they think this is normal/ Those of us who have been in the game a long time know differently.

  2. penney

    Low interest raes are not over yet. This is a response to supply and demand. Look at the charts fall 2010. We have seen 3.5m homes forclosed on, new bank settlemnt should help 750k home owners, we have 11m homeowners in trouble. Tells me we have not seen the last of the housing crisis. Stocks have had a good run, investors are selling bonds and investing in stock therefore putting more bonds on the market, dont forget supply and demand. The world economy is not out of the woods yet I am sorry to say and low interest rates benefit our federal government in financing our debt. The retail investor is scared to death and has good reason to be. The first sigh of new problems will once again prompt bond demand and drive rates down again. This wont last forever but needs to happen in order to move forward.