Why Do Interest Rates Matter?

Why do interest rates matter when you go to buy a home?


When I bought my first home I didn’t understand the impact that an interest rate could have on my ability to afford a home loan.  I am going to explain why interest rates matter and how they influence what you can afford to buy.


The interest rate is the amount a lender charges you to borrow money and an interest rate affects your monthly loan payment.  Take a look at these general examples…

If you have a home loan for $400,000, at a 4% interest rate, your monthly principle and interest payment would be $1910.  At 5% the payment rises to $2147 P&I, and at a 6% interest rate it goes up to $2398 a month.


Because the interest rate affects your monthly loan payment, it in turn affects your Debt to Income Ratio.  A Debt to Income Ratio is just a fancy term to explain what percentage of your income is going towards your debt each month. It’s one of the things lenders and mortgage providers use to determine how risky it is to lend you money. Note that expenses such as groceries, utilities and gas, generally don’t factor into your DTI ratio. Interest rates will affect your Debt to Income Ratio because as your interest rate increases, so does your payment, resulting in a higher DTI ratio.


As a general guideline, 50% is the highest DTI ratio a borrower can have and still get approved for a mortgage. Ideally, lenders prefer a debt-to-income ratio lower than 36%, with no more than 28% of that debt going towards servicing a mortgage or rent payment.  The DTI ratios vary from lender to lender.


Take a look at these general examples so you can calculate your DTI…

First, total up all of your monthly debt such as … (example below)

-Estimated mortgage payment $2147 ($400,000 loan at 5%)

-Property tax and property insurance $150

-Credit Card Debt $150

-Car payment $350

-Student loans $200


THEN take the total monthly debt divide it by your total gross income (monthly income before taxes) in order to get your monthly debt to income ratio.  If you are over the 50% DTI ratio then it is very likely you will need to pay down some of your debt to qualify for the loan or borrow less money for the house so your mortgage payment is less expensive. So, as you can see a higher interest rate may increase your monthly debt and affects how much you can borrow.


An interest rate also determines how much extra money you will pay in interest over the life of the loan to the bank. Using the same example of a $400,000 loan at a 4% interest rate, you will pay $287,478 in interest to the bank over the 30 year loan.  At a 5% rate, you’ll pay an additional $373,023 over the life of the loan. And at a 6% interest rate, you’ll be paying an extra $463,353 in interest to the lender!  This means at 6% you’ll pay a total of $863,353 over the life of the 30 year loan. As you can see interest rates matter! They affect how much you will pay and how much you can afford. Before jumping into a loan, give us a call to see if you are getting the best rate possible.


If you are ready to buy, sell, or invest, Pinyon Properties is your real estate one stop shop!



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