Why you shouldn’t panic when mortgage rates rise

Mortgage interest rates are rising, but rushing to buy a home before prices rise further will lead only to worse financial challenges.

I’ve always thought of homeownership as a kind of train.

As renters, you’re running behind it, trying to catch up, and then, when you finally have enough spring in your step (or money in the bank) you jump! and catch hold of the train, which sails away with you in it.

The problem is that the train seems to be accelerating all the time, not slowing down.

That’s for multiple reasons, all of them not good. There’s home prices, up a third since 2020, while at the same time, real wages clearly haven’t risen nearly that much.

Source: FRED

And then there’s mortgage rates, which are starting to rise after a decade or more of incredibly low rates. As of this month, 30 year fixed rate mortgage interest rates have risen from 2.96 to 5.27% over the past year.

And at least one expert is saying that 6% by the end of the year isn’t too far fetched.

(Who knows, if you’re reading this in the future, even 6% might feel like a dream.)

So you may feel like the train is pulling away from you, and you have to act fast. But before you sprain your ankle trying to catch the moving train, here are some reasons why you don’t want to panic.

How much do interest rates matter?

There are two ways to think about a large purchase:

  • How much it costs per month
  • How much it costs in total

I think it’s a smarter move to think about the total cost, since over the long term, the less you spend would seem to me to be a better, more representative figure.

But sometimes, you may want to think about the per-month charge too, because if that figure isn’t affordable, then it doesn’t matter what the total cost is.

So let’s look at how interest rates affect monthly payments.

Take a home with a $400,000 price tag, and let’s assume you put 10% down. So that’s a $360,000 mortgage.

For a 30 year mortgage, the monthly payment (principal and interest only) is $1,719 per month at 4%, and $1,933 at 5%. Meaning that the difference between 4% and 5% is about $214 per month.

At 6%, you’re looking at $2,158, a difference of $226 from 5%.

That’s a lot, but it’s not insane.

At these prices and rates, each interest rate percentage point jump appears to lead to a roughly 10-15% increase in monthly payments.

A higher down payment can offset the interest rate

A higher interest rate means less home that you can afford. But if you haven’t jumped on the homeownership train, this will hopefully mean that you have time to keep saving some money.

And that’s good, because a higher down payment can offset the extra payments from the interest rate.

Let’s take that $400,000 home again. We know that if rates went from 4% to 5%, that’s an increase in monthly payments is $214.

How much extra would you have to put away to offset that?

Well, it turns out that you’d need to save another 10%. to get back down to that 4% level.

Actually, it’s better than that. At the original 10% down payment, you’d be paying PMI. By getting that extra 10% down (so 20% total), you’d be saving upwards of a few hundred dollars a month.

Not easy, but not impossible.

There will be a housing crash

This is all assuming that home prices go up forever, and there is never a housing crisis ever again. Good joke!

While I can’t predict the future, I think we can look to history to note that prices and demand have fluctuated. I don’t think we’re always going to see insane crazy demand for homes like we are now.

Don’t run the risk of buying at the top of the market. If you have to wait, maybe you want to anyway.

A bad financial plan doesn’t get better because it’s about to get worse

I know that many people have their identities wrapped up in owning a home. It’s powerful, and I understand it.

But chasing a fantasy without looking at reality is not going to give you that fantasy.

What I mean by this is that, in your panic that the housing market is slipping away from you forever, you may be tempted to YOLO it and just buy a home now, regardless of the expense of it. After all, it’s only going to be harder later, right?

This is the worst possible thing that you can do.

Do you know what they call a home that you can’t afford? They call it a foreclosure.

A bad financial plan doesn’t get better because it’s about to get worse. If it’s bad, it’s just bad.

I’ve talked about what you need to be able to afford a home. This is definitely conservative, but financial conservatism, when it comes to debt, helps keep you safe.

Stay the course. Study the fundamentals. Don’t just assume that everything will be okay. If you can’t afford it, don’t buy it.

You can build wealth without homeownership

Let’s be honest; this whole thing sucks.

Our parents, and our parents’ parents, didn’t have to contend with home prices ten times their yearly salary like many people do today. This is unconscionable and just plain unfair.

But while I want you to own a home if you can afford it, I want to remind you that you can build wealth without homeownership.

You have just as many tools as everyone else for investing and saving money. And without a mortgage, you won’t be saddled with hundreds of thousands of dollars of debt in your prime earning years.

And you won’t ever have to replace a leaking roof, deal with a boiler blow-out, buy a lawnmower, or any of the other unaccounted-for costs of being a homeowner.

Full disclosure

Now, I realize that this is all easy for me to say, because I currently own a home. But I didn’t expect to be able to ever be a homeowner (I lived in New York City for years, after all) and never factored it into my long-range plans.

I bought because it made financial sense for me. If it hadn’t, I wouldn’t have done it.

And I rather you be a renter your entire life than buy a home that you can’t afford.

And who knows: maybe one day we’ll have strong unions again, and we can combat wage inequality and prevent investors from turning every home into an AirBnB. I’d be the first one to jump on that train, for sure.

But enough about me. Are you looking to buy a home? How are you handling the process? I’d love to hear more in the comments below.

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