If you’re looking to buy a home, you’re seeing a lot of talk about interest rates. You may have heard that interest rates are rising. But what exactly does that mean for you as a buyer? How much do interest rates matter when buying a home?
We’re going to answer that critical question, complete with a comparison of a home purchase at different interest rates. But first, let’s cover a few basics, like what exactly an interest rate is and what is considered a “good” interest rate.
What is an Interest Rate?
An interest rate is simply the cost of borrowing money.
Generally, interest rates are lower on debts that people are most likely to repay. Even though home loans can be hundreds of thousands of dollars, they aren’t overly risky for lenders because most people prioritize making their mortgage payments over making every other payment. And, if a borrower defaults on a home loan, the lender can foreclose on the home and resell it to recoup their losses. So interest rates on home loans are typically lower than with other types of debts.
What is a Good Interest Rate on a Home Loan?
A “good” interest rate on a home loan changes over time. At the turn of the millennium, the going rate for a 30-year mortgage was around 8%. During the Great Recession, interest rates fell below 5% for the first time in recorded history. And the average for 2021 was an unprecedented 2.96%.
The Federal Reserve raises and lowers interest rates to help manage the economy. When times are tough, the Fed lowers interest rates to incentivize people to spend money and boost the economy. But during periods of inflation, as we’re starting to see in 2022, the Fed raises interest rates to slow inflation and keep economic growth manageable.
How Much Do Interest Rates Matter?
Interest rates are perhaps the most important detail of a standard home loan. Interest rates impact your monthly payment and your interest expense over the term of the loan. When interest rates increase, your buying power decreases.
If you’re looking to buy a $1 million home, for example, with a 30-year fixed interest rate and 10% down payment, here’s what your payments would look like (using the Bankrate mortgage calculator):
At a 3.5% interest rate: your monthly payment would be around $4,765, and you’d pay $555,015 in total interest expense over that 30-year period.
At 4.0%: your monthly payment would be around $5,020, and you’d pay $647,072 in total interest expense.
At 4.5%: your monthly payment would be around $5,284, and you’d pay $741,251 in total interest expense.
In this example, an increase of a single percentage point to your interest rate raises your monthly payment by over $500 and adds over $185,000 to your total interest expense.
How Do I Get the Best Interest Rate?
There are several things you can do to keep your interest rate as low as possible:
Build and maintain excellent credit. The higher your credit score, the lower your interest rate.
Shop around when looking for a lender. Different lenders offer different rates and terms.
Increase your down payment if possible to get a lower interest rate.
Buy down your interest rate by purchasing “points” up front from your lender.
Buy when interest rates are low. Like today.
Interest rates are projected to increase as the Fed fights inflation in 2022. And while rates are still exceptionally low by historical standards, every percentage point matters. So by purchasing your new home now, you can avoid paying more in interest expense as interest rates rise.
Are you ready to buy your new home? Contact the experts at Sequoia Real Estate. Our team of buyer’s agents understands how real estate financing affects your home purchase. We can put you in contact with reputable lenders, help you find the right home, and help you navigate the buying process. And because sellers pay all real estate agent fees, it costs you nothing to get professional representation in your real estate purchase.
Don’t wait…interest rates are creeping up.