Mortgage rates are the most talked about factor in the mortgage industry. When they rise, people tend to panic. When they fall, everyone rushes to take out a mortgage. So how can rising interest rates ever be a good thing? There are reasons that we will discuss below. Of course, as with all good, there are bad sides too and they might not be as obvious as you once thought. Let’s take a look.
Why Rates Change
First, let’s look at why interest rates change. If the Fed never stepped in and regulated things, the housing industry would be in constant turmoil. Think of it like a supply and demand type thing. When things are good in the economy, rates tend to increase. This is to keep things on an even keel. If rates stayed too low for too long and the economy was doing well, people would keep buying until there was no more supply. This would drive prices up and inflation would be out of control. On the other hand, when unemployment is high, interest rates tend to drop to give people more buying power. It is a checks and balances type of system.
Reasons Rising Interest Rates are Good
So why would rising interest rates be good? First, it is a sign the economy is doing well. This is something we all want to hear. That means unemployment rates are down and buying is up. This is much better than a sluggish economy where everything needs a little boost in order to thrive. While you might not think a higher interest rate on your mortgage is a good thing, you will think it is good when you look at your other investments. It is a little give and take. Yes, you have to pay slightly more on your loans, but you make it up on your investments.
Another reason higher interest rates can be good is it gives you less competition. If you are in the market to purchase a new home and the economy is thriving, you may have a lot of competition. You may even find yourself in a bidding war. This means you may have to bid more for the home than you wanted to or you may lose the bid altogether. With higher interest rates, though, there is usually a smaller pool of potential buyers. This allows you to give the bid you want and possibly have a better chance at winning the bid on the home.
Reasons Rising Interest Rates are Bad
Now for the bad. Of course no one likes rising interest rates. First and foremost, it means a higher mortgage payment. This means two things.
- You pay more interest over the life of the loan. Even 0.5% can add thousands of dollars on the total cost of your loan.
- A higher mortgage payment means a higher debt ratio, which may mean a loan denial.
Every lender looks at your debt ratio in order to qualify you for a loan. That debt ratio includes all of your monthly payments, including the new mortgage payment. The new mortgage payment is based on the interest rate. If interest rates rise, you have a higher payment. This payment then takes up a larger portion of your monthly income. This means you have a higher debt ratio. If you were a borderline borrower with a debt ratio close to what the program allows, you might find yourself without an approval because of the higher rates.
Even if your debt ratio is okay, you might not be comfortable with the higher rate. It happens all of the time – lenders approve borrowers for more than they can afford. Even if on paper it shows that a borrower can afford a specific payment, he/she may not be comfortable with that payment. We never recommend that you take a payment you are not comfortable paying. This only puts you at risk down the road. If you find it too hard to keep up with the payments, you could end up losing your home. Rather than taking a risk, you should proceed with caution.
Impending Higher Rates Make People Buy
Have you ever heard the threat of rising interest rates and found yourself reacting? You are not alone. Everyone has the tendency to do this. When people hear that interest rates may rise soon, they rush out and buy or refinance now. This can give the economy the boost it needs. This is not to say you should be the one to run out and refinance or purchase a home, but you could give it careful thought. No one can predict for sure what will happen to the interest rates in the future, but if there is a suspicion of rising rates, it is best to do what your gut tells you.
There are good and bad sides to rising interest rates. Because it is an inevitable part of the mortgage process, you have to learn to handle it. Take a close look at your financial situation and figure out what you can afford. Do not just take a mortgage because you love a home and want it no matter what. A mortgage is yours for the next 15 to 30 years. Make your decision wisely. If rates rise and you are not sure about the new payment, wait until they fall again. They rise and fall all of the time. It is not worth making a hasty decision and regretting it down the road. This is one of the largest investments of your life, take your time and make the decision that is right for you.