3 Ways the Rise in Federal Interest Rates Impact Homebuyers

interest rates

The Federal Reserve just announced the second consecutive .75% interest rate increase in two months as it tries to control escalating inflation without creating a recession. This increase takes the funds rate to its highest level since December 2018.

So, what do these federal interest rate increases mean for you as a homebuyer? While the federal funds rate doesn’t directly influence fixed-rate mortgages, it does impact rates for adjustable-rate mortgages (ARMs), auto loans, and credit cards. That’s why it’s so important to connect with a mortgage lender that can help you understand exactly what this means based on your specific financial situation. Our Home Loan experts can walk you through everything you need to know to make the best choice for you and your family.

Let’s look at how these rates might affect your home buying experience.

1. Your Purchasing Power May Be Decreased

Higher rates mean higher mortgage payments, and you may end up adjusting your monthly budget numbers if you’re trying to stay within the 28%/36% guidelines for housing and other debt. Higher interest rates diminish your buying power, and you may end up lowering your price range for a home.

For every 1% increase in interest rates, buying power decreases by about 10%.

Rising rates can reduce the value of the home you are able to afford, or more specifically, the amount lenders are willing to loan you. For example, the monthly payment in 2022 on a median-valued $400K home with 20% down is about $1,875, compared to last year’s $1,335, an increase of more than $500 per month. A loan at a rate of 5% would add $238 per month, approximately 13% more on your monthly payment.

The most important number to consider when buying a home is the home’s total monthly cost, including the mortgage payment, property taxes, and the cost of homeowners insurance.

As rates go up, the amount of home you can afford goes down, and you may end up qualifying for a smaller loan amount. The amount of a lender’s preapproval offer is determined by both your down payment and the monthly payment you can afford based on your debt-to-income ratio (DTI). A higher monthly payment usually means lower loan amount. First-time homebuyers who don’t have the funds from the sale of a home may be unable to offset a lower loan amount with a higher down payment.

The good news is that home prices tend to stabilize as rates rise, and sellers may even lower prices if they don’t receive offers. Right now, however, there’s not enough inventory on the market to keep up with demand, particularly when it comes to existing homes. Current demand could sustain these higher prices for a while, temporarily pricing some buyers out of the market as they have difficulty finding homes in their price range.


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2. Interest Rates Will Go Up on Other Debt You’re Carrying

Rising rates affect home buyers and homeowners in other ways as well. Credit cards, car loans, private student loans, and variable rate loans like home equity lines of credit (HELOCs) are on the rise. When the Federal Reserve raises the federal funds rate, interest rates tend to go up everywhere, shrinking your available budget even more.

If you’re preparing to buy a home, creating and following a budget can help you manage those increasing costs, pay down debt, and put you in a stronger financial position to purchase a home.

As a current homeowner, rising prices could mean that you have more equity in your home. Using that higher home equity could be to your advantage for debt consolidation by pulling out cash in a home equity loan or home equity line of credit (HELOC). Even with rising rates, rates on these types of loans are typically lower than those on credit cards. Rolling higher-interest debt into your mortgage can reduce the amount of money you pay in interest overall and allow you to pay off debt at a much lower rate.

Something both homeowners and home buyers can benefit from is switching to a lower interest rate credit card or personal loan.

3. You May Want to Consider an Adjustable-Rate Mortgage (ARM)

If you’re an existing homeowner with an adjustable-rate mortgage (ARM) that is scheduled to adjust, the rate is probably going up along with everything else.

Adjustable rates aren’t necessarily a negative thing, as the initial low rates can save you money in the short and medium term. Buyers with an ARM can lock in lower rates for a set period of time, usually 5,7, or 10 years.

Tip: Figure out what your highest interest rate may be on your adjustable-rate loan, and what your potential monthly payment will be at that rate. Plan your budget around that higher amount and stash the difference between that and your actual payment in a savings account. When rates go up, you’ll have already accounted for that, plus you’ll have a little extra in your savings.

At Citadel, your ARM rates will never be adjusted higher than 2% than your last rate or adjustment and never higher than 5% over your initial rate. Citadel will also give you plenty of notice before your rate is adjusted, usually 7 to 8 months before your first adjustment, and 2 to 4 months before each subsequent adjustment, so you’ll have time to plan ahead. An ARM is still a 30-year loan, and you’ll have the option to refinance into a fixed rate in the future.

Fixed vs. adjustable, loan, terms, rates – it’s a complicated subject, but if you know what you’re getting into and what your options are when the rates rise, an adjustable-rate mortgage can be to your advantage. That’s why it’s vital to meet with our mortgage experts. They can work with your specific financial information and situation, help educate you, and find a mortgage that works for you.

What Can You Do to Be Better Prepared to Buy a Home?

Even with rising interest rates, there are a number of things you can do to be prepared for positive home buying experience.

  • Improve your credit score. Being able to effectively manage the debt you take on is important, and a big part of how your interest rate will be determined by your lender. The higher your score, the better. Here are 4 Strategies for Improving Your Credit Score.
  • Pay down existing debt. Your debt-to-income (DTI) ratio is another important factor that lenders consider, essentially how much income you have vs. your required monthly debt repayments. You can either increase your income or reduce your debt by focusing on paying it down.
  • Increase your down payment. The more you can afford to put down on a home, the less you will need to borrow. Smaller loan = smaller monthly payment, and you may even get a more favorable rate as the loan is less risky to the lender.
  • Get preapproved before home shopping. It’s free and there’s no obligation. You’ll know exactly how much you can afford to spend on a home, and it also shows sellers you’re serious. You have the financing to back up your offer. Schedule a consultation!

Once again, smart budgeting can help you accomplish these goals, especially when you use Money Manager. Even small ways of cutting back on spending can add up quickly, freeing up money to pay down existing debts or save for a down payment. Seeing your finances in black and white in front of you helps you find those opportunities and keep a closer eye on your money. Watching your savings grow and your debt shrink can go a long way toward keeping you on track.

Citadel Is Here to Help

With so many factors to consider, buying a home can be a long and complicated process. Understanding how mortgages work can be overwhelming. After all, how many mortgages does the average person have? Maybe 3 to 5 in a lifetime? Our Citadel Mortgage team are experts at this and can walk you through the entire the mortgage process. They keep a close eye on rates and shifts in monetary policy and are dedicated to helping our members find the right mortgage for their needs.

Come in and talk to us. It’s worth it.

Looking to consolidate debt into one monthly payment? A personal loan can be a great option.