Effects of Interest Rate on Mortgage Payments

After renting a house for a long time, contemplating on the decision of buying a home is a big step for any buyer, specially the first time buyer. Over this, there is affordability to consider which more often than not makes a buyer decide to wait and buy later. However, increasing interest rates also make the decision even more difficult as this increase, pressurizes to find a home sooner than later. The rates however, are not very likely to get better than they are now. Let’s have a look at how the interest rate affects a buyer’s affordability. Is it actually better to wait or to buy now?

The mortgage rate determines the interest you pay on your mortgage.

Monthly payment of mortgage includes:

  • The interest charged on the outstanding loan balance.
  • A part of the principal loan amount which reduces the outstanding loan amount.

When there is a change of 1% in the rate of interest, it converts into a difference of at least 10% in the monthly mortgage payment. For instance: at an interest rate of 4% on a $300,000 loan, a standard 30-year fixed-rate mortgage, translates to a monthly payment of $1432, whereas, if the interest rate on the same increases to 5%, the monthly payment comes to be $1610.

The difference here is of $178 per month! Over 12% higher.

1% may not sound much when deciding to buy a home, but it impacts on the monthly payments in a big way. Buyer’s purchasing power gets drastically hit by that little increase in the rate of interest.

Other than this, waiting also puts that property rates at risk. A home available to buy at $250,000 today may be priced at $275,000 at a later time probably when you decide to go ahead and buy. It is better to rather buy today and save from unforeseen rise in property and interest rates at a later time.

What is a down payment and how does it affect the interest rates?

A down payment is a part of the total cost of a home that is paid upfront by the buyer at the time of purchasing by mortgage. It is basically the difference between the cost of home and the money borrowed to purchase it.

Example: You want to buy a home for say, $300,000. You have saved $60,000 for the same and decide to pay upfront. So you bring in the $60,000 down payment (amounts to 20 percent of the home’s cost). Now, you’ll only have to borrow $240,000, which along with the interest will be converted into monthly payments with a 30-year mortgage.

Typically, more the down payment is, lower is the rate of interest and the monthly payment for the loan. Why? This is because down payment is your investment in your home. By putting more money down, you take on a portion of risk from the lender, who in turn offers you potentially lower rate of interest on mortgage to reciprocate.

Lowest mortgage interest rates can be availed by typically paying a down payment of 20% or more of the cost of the home.

Purchasing a home with a down payment of 15%, 10%, or even less, however, it’s not uncommon. There are government backed loans out there like VA Loans and FHA Mortgages, which qualifying home buyers can avail at little or no down payment. Although, by availing this benefit in such programs, one shall have to pay for mortgage insurance. This would add up to one’s monthly expenditure that is to be paid along with the mortgage payment. To compare what amount of down payment is the best for you to make, it would be ideal to understand the different mortgage options available to you and their requirements.

One good reason to pay a higher down payment is that the more is paid up front, lesser will be owed on the mortgage. As the down payment is subtracted from the cost of the house, the amount of loan taken becomes smaller with a larger down payment. This converts into smaller monthly payments.

What do you think about buying a home instead of renting and what should an ideal down payment percentage be, do let us know in the comment box below.  

Leave a Reply

Your email address will not be published. Required fields are marked *