Mortgage Rates Are on the Rise, and It's Messing With People's Home Buying Plans

Rising interest rates are starting to impact how much house people can afford. It’s another blow to homebuyers, who are already struggling with low inventory and rising prices.

Freddie Mac’s current benchmark rate for a 30-year fixed-rate loan hit 3.17% on Thursday, a rise of .08 percentage points from the previous week. Money’s mortgage rates, which focus on average borrowers and daily rate changes, are currently averaging over 3.5%.

Mortgage rates have been steadily rising since January, after hitting an all-time low of 2.65% early on. Slow at first, the increases have picked up steam and rates have now risen for seven consecutive weeks.

While it’s impossible to predict exactly what rates will do next, it seems pretty clear that the days of sub-3% mortgage rates are behind us. What does this mean for homebuyers?

Higher rates “really change how much you can afford to spend on the sticker price of a house,” says Daryl Fairweather, chief economist for online brokerage Redfin.

In other words: when rates were at 2.65% a buyer with a 20% down payment and $2,000 monthly budget (before property taxes and homeowner’s insurance) could afford a home asking around $620,000. With rates now at 3.17% that same buyer would be looking at homes asking closer to $580,000. That’s a loss of $40,000 in buying power in under three months.

That loss will be amplified if rates continue to creep higher. At 3.25% they’d be at about $574,000.

How do mortgage rates impact buyers’ plans?

Redfin recently conducted a survey to see how such a change in rate would affect borrower’s plans for buying a home.

Of the people surveyed, 46% said they would alter their buying plans in some way if average rates rose above 3.5%, where rates were a year ago. That could mean speeding up their buying plans to take advantage of lower rates, slowing down their plans to see if rates go back down, or lowering their price range to get a more affordable payment.

Some buyers are already starting to modify their home-buying plans.

Alysandra Nemeth, a Redfin agent serving South Boston and Rhode Island, says that she has seen an increase in the number of buyers who are paying closer attention to interest rates and how changes can affect how large a home loan they can qualify for. A higher rate, and higher monthly payment, can change your debt-to-income ratio and reduce the amount a lender is willing to finance.

However, 44% of those surveyed said a 3.5% rate would not change their home-buying plans at all. Only 10% of people said they would cancel their home-buying plans altogether.

While some homebuyers are paying more attention to changes in interest rates, the purchase market remains extremely active. Melissa Cohn, executive mortgage banker at William Raveis Mortgage, hasn’t seen rates affect buyers yet but does see a change among homeowners thinking of refinancing, particularly in states where closing costs are higher.

Data from the Mortgage Bankers Association matches Cohn’s experience. Refi applications have been down for six of the last seven weeks as rates have increased. In its most recent Mortgage Application Survey, refinance loan applications were down 5% from the previous week and 13% lower than the same week last year.

How do mortgage rates impact home prices?

Mortgage rates tumbled as the full effect of the COVID-19 pandemic took hold last year. Rates set 17 different record lows between March 2020 and January 2021.

Low interest rates created a home buying frenzy as borrowers found they had more buying power. The surge in demand for homes led to a severe shortage of homes available for sale. In turn, the lack of inventory has sent home prices skyrocketing.

According to the National Association of Realtors, the median home price in February was $313,000 compared to $270,400 in February of 2020, a nearly 16% year over year increase. Earlier during the pandemic, higher prices were offset by historically low interest rates, as rates go higher that may no longer be the case. Interest rates increasing and prices rising at the same time could put homeownership out of reach for many borrowers, especially first-time buyers.

Nemeth has already seen a shift in how some buyers approach their home search. Because many homes are selling over the asking price, she says more buyers are opting to lower their search range by $50,000 to $100,000.

“They want to be able to have more buying power in order to accommodate those rising interest rates as well as accommodate maybe going over that asking price in order to offer more than the list price,” she says.

Will mortgage rates keep rising?

The recent spike in interest rates is due to a number of factors. Treasury yields have increased by more than 50 basis points since the beginning of the year. Currently, yields are above 1.7% and trending higher.

The yield paid on the 10-year Treasury bond serves as a benchmark for mortgage rates. The average interest rate on a mortgage loan is typically 1.8 percentage points higher than the yield on the 10 year Treasury. If yields rise, rates tend to rise.

While mortgage rates still aren’t rising quite as fast as yields, there is the potential for a catch-up rate jump in the near future.

Recent economic indicators, including nearly 400,000 new jobs added in February and the distribution of funds from the most recent stimulus package, are pointing toward a renewed and sustained recovery. As the economy continues to reopen and activity increases, inflation, which so far has been a non-factor, could lead to higher mortgage rates as well.

For her part, Fairweather believes that if the recently passed $1.9 trillion stimulus package successfully boosts economic activity, interest rates could rise to the pre-pandemic level of 3.5%, but more people may be able to buy homes.

“That would alter the dynamics of the housing market, though it wouldn’t necessarily put a damper on it,” says Fairweather. “The financial relief coming to families earning less than $150,000 will give more of them the desire and means to buy a home. That will result in more demand for affordable homes. That’s different from what we’re seeing now, which is a housing market driven by wealthy people purchasing relatively expensive homes.”

Cohn, however, doesn’t see a dramatic effect on rates in the near future or even later this year. “The real question is, where rates will be in two years? Will we be back at a 4% rate environment?” she says. “I think that’s something that people should think about.”

Editor's note: This story was updated to correct the home price for a borrow with a 3.25% mortgage rate and a $2,000 monthly payment.

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