How Does a 1% Interest Rate Increase Impact Your Buying Power?

When you're considering buying a home, it's easy to focus solely on the price to determine whether it fits your budget. However, mortgage rates play an equally important role in affordability, and they may have changed since the last time you did the math. Mortgage interest rates fluctuate frequently, and even small changes can significantly impact not only your monthly payment but also how much you can afford to spend on a home.

With the volatility in the mortgage market over the past couple of years, understanding how interest rates affect your buying power is crucial. Here's how mortgage rates influence your monthly payment:

How do mortgage rates affect your monthly payment?

Each month, your mortgage payment covers both the principal—the amount you borrowed—and the interest on that loan. Early payments typically consist of more interest, while later payments gradually shift toward paying down the principal. Even small changes in interest rates can significantly affect your monthly payments and how much house you can afford. A half or full percentage point in either direction can open or limit your options.

How much difference does a 1% change in mortgage rate make?

Let’s break down how a 1% change in mortgage rates can affect your monthly payment and buying power. In these examples, we assume a 20% down payment and a 30-year fixed-rate mortgage. Taxes and insurance are not included in the calculations.

• For a typical U.S. home valued at $346,900:

  • At a 7% interest rate, your monthly payment would be $1,846.
  • At 6%, your payment would drop to $1,664—a savings of $182 per month.
  • Over 30 years, this 1% drop would save you $65,691 in interest.
  • If your budget is $1,846 per month, a 1% rate drop would allow you to afford a home costing $30,480 more without increasing your payment.

• For a home in San Diego valued at $919,800:

  • At a 7% rate, the monthly payment is $4,896.
  • At 6%, it drops to $4,412—$484 less per month.
  • Over 30 years, you’d save $174,178 in interest.
  • A 1% rate drop could let you afford $80,772 more on a home without raising your payment.

Similar calculations can be made for homes in different markets, like Atlanta, Dallas, and Pittsburgh, showing how just a 1% drop in rates can greatly improve your purchasing power.

How much difference does a 0.5% change in mortgage rate make?

Even a half-point change in interest rates can have a noticeable impact on what you pay monthly. For example:

• For a home in Phoenix valued at $451,600:
  • At a 7% rate, your payment is $2,404.
  • At 6.5%, it drops to $2,284—a savings of $120 per month.
  • Over 30 years, you’d save $43,233 in interest.
  • A 0.5% rate drop could allow you to afford $19,059 more on a home without increasing your payment.

Tips for navigating volatile mortgage rates

With rates constantly changing, here are a few tips to help you handle the uncertainty:

1. Build flexibility into your budget: Ensure you have room in your budget for rate changes, especially if you’re shopping at the upper end of your price range.
2. Talk to lenders: Work with a lender you trust to explore financial scenarios and the possibility of buying down the interest rate.
3. Prepare your finances: Strengthen your credit score to qualify for the best rates.
4. Lock in your rate: Once you’ve signed an agreement to purchase a home, consider locking in your mortgage rate to protect yourself from future increases.
5. Consider refinancing later: If rates drop after you buy, refinancing can save you money in the long run, though it comes with closing costs.

Should you wait for mortgage rates to drop?

No one can predict exactly when or how rates will change, so waiting for a rate drop might not always be the best strategy. Home prices could rise in the meantime, offsetting any potential savings from a lower rate. It’s wise to start building relationships with lenders early and keep an eye on the market, but don’t miss out on the right home if you can afford it now.