Mortgage Payment and Interest Rates

The amount of a monthly mortgage payment will be directly impacted by the interest rate that is charged for the mortgage.  Home buyers are usually looking at the total monthly mortgage payment to determine what their budget is for buying a home.  Higher interest rates on mortgages means looking for a home with a sales price that can get to the desired monthly payment a buyer needs.  This article looks at how the interest rate will impact the monthly mortgage payment. 

Fixed Rate Mortgage

A fixed rate mortgage means that the interest rate for the mortgage will remain unchanged for the length of the loan.  So if the mortgage is a 30 year fixed mortgage with a 5% interest rate that 5% will be the same the entire 30 years the homeowner has the mortgage for.  The mortgage term can be also be 15 or 10 year terms depending on what the homeowner opted for when buying or refinancing the house.  With the fixed interest the principal and interest payments will remain the same for the length of the loan but the actual mortgage payment can still be subject to change if the payment includes escrowed insurance and tax payments.  Insurance rates can go up with the price of inflation and taxes as well can increase or decrease based on the value of the home.  In most cases the taxes increase as the home price increases.  What that means is that the portion of the monthly payment that is for taxes and insurance can adjust which causes the overall payment to adjust.

Most home buyers when buying a home are looking for a certain payment amount that fits within their monthly budget.  For instance a homeowner who wants to buy a home where the monthly payment (excluding insurance and taxes) is no higher than $1400 a month, they are looking at a home priced at $415,000, with putting 20% down, for 30 years at a 3% interest rate.  When the interest rates goes to 4% the home buyer is looking at a monthly payment of $1585.02 per month.  At 5% interest the monthly payment is $1782.25 per month.  As the interest rates go up so do the monthly payments when the house price stays the same.

In order to keep the monthly payments the same ($1400 as in the above case) the home buyer would have to buy a home priced around $325,000 with 20% down at a 5% interest rate for 30 years.  The interest rates can have a big impact on home buyers being able to buy a home especially in markets where homes are priced higher.  So where the buyer in the previous example could afford to buy a home where on the low end prices started at $400,000 as interest rates move up to 5% (and higher) they are no longer able to buy a home in that market.

If the homebuyer is putting less than 20% down than the total house price drops even further.  With a 10% down payment and 5% interest rate for 30 years the home buyer is now looking for a home priced at $290,000 or lower. 5% down payment brings the house price down to around $275,000.  As one can see interest rates and the amount of down payment can greatly affect the purchase price of a home for buyers.  Add to that escrowed insurance/tax payments and the total house price drops even more to fit the $1400 a month budget.

Adjustable Rate Mortgage

With an adjustable-rate mortgage (ARM) the mortgage has an interest rate that can adjust throughout the term of the loan.  Usually the amount the interest rate can increase and how many times it can adjust are fixed by the terms of the loan.  ARMs are commonly referred to as 3/1, 5/1, 7/1.  With a 3/1 ARM for example the interest rate is fixed for three years and then can adjust once a year.  The 5/1 and 7/1 fixes the interest rate for five and seven years.  ARM type loans are more common in commercial mortgages and were common in the past for residential mortgage around the time of the mortgage crisis in 2008.  After the 2008 crisis the use of ARM mortgages for residential loans dropped quite a bit but they are making a comeback due to housing prices these days.

Because the interest rate risk is more on the borrower with an ARM the mortgage lender is able to offer lower interest rates up front as compared to a 30-year fixed mortgage.  For example as of the publishing of this article a 5/1 year ARM has interest rates in the low to mid 4% which compared to a 30 year fixed mortgage of mid 5% is about a $185 dollar monthly savings on a $400,000 home.  Of course, there is risk involved that if the home buyer wants to stay in the home longer than five years the interest rate and monthly payment can jump up if rates are higher.

The other side of that though is the fact that if interest rates happen to go down as compared to when the mortgage was first obtained then the ARM mortgage can become cheaper as it’s interest rate will also go down.  Guessing the interest rates in the future is just what it is, a guess.  No one can really know if the record low interest rates of the recent past ever come back or rates will be high for the foreseeable future?  If a home buyer does not plan in being in the house for more than five or seven years than an ARM mortgage might be suitable for them.  

Housing Affordability

While prices for homes all over the US have been going up, so long as mortgage rates were going down buyers were ready to buy.  As mortgage interest rates have begun to climb there is some slow down in buyer activity.  Some buyers had to step away from the market if they were not able to buy a home that fit their budget.  If fewer sellers decide to sell as there is nothing to buy then the market will remain stable where it is.  Forced selling due to economic conditions could change that.

Some home buyers in the past decided to buy a new home and not sell their old home right away in hopes of getting more money from the sale down the line.  With interest rates rising some of that vacant home inventory may make its way onto the market.  The Federal Reserve also continues to talk about needing to control out of control inflation and real estate can be a ripe target in order to bring inflation numbers down.  Time will tell.

Final Thoughts

Mortgage interest rates are on an upward trend which is forcing more buyers to sit out this market.  ARM mortgages allow some buyers to buy a house at a lower interest rate but with potential risk that the mortgage will be more when their mortgage can be adjusted and rates are higher.  The Federal Reserve wanting to bring inflation back into check will be looking at all options closely in deciding what path works best.

Additional Resources

• Top Mortgage Questions To Ask Before Buying A Home - Understanding a mortgage and what the requirements are for each lender is important in order to get the best terms possible.
• How Long Does It Take To Close On A Mortgage - There are a number of steps buyers need to take in order to make sure their mortgage stays on track.  The amount of time that is involved is used to make sure every step is done properly.
• No Closing Cost Mortgages - There are mortgages where buying can close with low or no closing costs.  Learn about what closing costs are involved and what one can be expected to pay.
• Mortgage Calculator - Using information like home price, interest rate, down payment and more learn how much a mortgage payment can be with this helpful calculator.

About the author: The above article “Mortgage Payment and Interest Rates” was provided by Luxury Real Estate Specialist Paul Sian. Paul can be reached at paul@CinciNKYRealEstate.com or by phone at 513-560-8002. If you’re thinking of selling or buying your investment or commercial business property I would love to share my marketing knowledge and expertise to help you.  Contact me today!

I work in the following Greater Cincinnati, OH and Northern KY areas: Alexandria, Amberly, Amelia, Anderson Township, Cincinnati, Batavia, Blue Ash, Covington, Edgewood, Florence, Fort Mitchell, Fort Thomas, Hebron, Hyde Park, Indian Hill, Kenwood, Madeira, Mariemont, Milford, Montgomery, Mt. Washington, Newport, Newtown, Norwood, Taylor Mill, Terrace Park, Union Township, and Villa Hills.