What Do Rising Mortgage Rates Really Mean for Would-Be Homeowners?

Higher rates might mean you don’t have as many options.

During the heart of the coronavirus pandemic, would-be homeowners saw mortgage rates repeatedly hit record lows. While they faced other challenges including surging home prices and limited inventory, these low rates made buying a home seem affordable to many.

Unfortunately, for those interested in buying their own homes, 2022 has been very different in terms of the mortgage market. Rates are up sharply from the start of the year, with the average interest rate on a 30-year loan now topping 5% when it was under 3% just a few short months ago. 

With rates up so much, many people considering purchasing a property may be wondering what this actually means for their ability to buy. 

Rising mortgage rates could affect monthly payments 

The first and most obvious impact of rising mortgage rates is the effect that higher financing charges will have on monthly payments. Obviously, if you borrow at a higher rate, your monthly costs will be higher due to the added interest.

Consider, for example, a homeowner who borrows $300,000 at 3% versus one who borrows the same amount at 5%. With a 30-year fixed-rate loan, the borrower with the 3% rate would pay a total of $1,265 in principal and interest payments each month. But the borrower with the 5% rate would see their payment jump to $1,610.

Coming up with an extra $345 each month could be a huge financial burden. If you can't afford to pay the extra interest, you may need to borrow less by either saving up a larger down payment or opting for a cheaper home. 

Rising mortgage rates could affect total borrowing costs over time

While many people focus on the monthly payment to see if their loan is affordable, it's also worth considering how much you'd end up paying over the life of the loan.

The 30-year mortgage at 5% described above would come with total repayment costs of $579,767 over the entire duration of the loan. But at 3%, total borrowing costs would be just $455,332. That means taking out a mortgage at today's higher rate, compared with last year's lower one, could lead to you paying an extra $124,435 over the duration of the time you are paying back your loan. That's a lot of extra money that could have otherwise been invested.

Rising mortgage rates could make qualifying for a loan harder

Not only will borrowing be more expensive at a higher rate, but you could also find that you have a more difficult time getting a lender to actually give you a loan.

Lenders look at your mortgage payment relative to your income. If your housing costs exceed a certain percentage of your pay -- usually around 28% -- then it will be harder for you to get approved for a loan and you may have less choice of lenders. And if your total debt -- including your new housing payment and other borrowing costs -- exceeds 36% of income, you could run into the same problem.

If your mortgage payment is hundreds of dollars more per month due to the fact your rate is a lot higher, then this will obviously affect whether you fit within these limits. 

Now, this doesn't mean you shouldn't buy a house because rates are high. Homeownership is still typically considered a good investment and rates are still relatively affordable -- especially by historical standards. They're also likely to keep going up so waiting for them to fall again could mean missing out on years of building equity and property appreciation.

But you may wish to consider making some other changes, such as choosing a slightly cheaper property, in light of the fact your home loan is almost definitely going to cost you more due to trends in mortgage rates this year.