When it comes to today’s housing market, there’s so much talk about interest rates. I think most people understand that a 4% interest rate is very low and that an 8% interest rate is high. But do you know how it actually impacts your costs, month to month? Do you understand how much you actually FEEL that percentage? Let’s talk about it.
Disclaimers!
Understand this first: The actual formula on how to calculate how much of your monthly payment goes to interest is more complicated than the ordinary mortgage holder needs to know. My objective today is to give you a quick understanding of how much a rate fluctuation might impact you and is not mean to serve as an absolute. The amount changes every month for the duration of a loan anyway, and most people are only concerned with how interest impacts them at the start, as the amount goes down over time. So, we’re focused on quick calculations for the early part of the mortgage.
Also, we’re going to operate off of averages for this conversation. This is meant to give you an understanding of how to ballpark how much you pay in interest every month. The actual number can vary buyer to buyer. For a more precise number, text me at 401.205.3456 and I’ll connect you to a mortgage professional.
Now let’s do the math!
Let’s say you’re financing $400,000 for the purchase of a home. Note, this isn’t the purchase price, it’s the loan amount. And say on that $400,000 your interest rate is 8.125%, which it was as recently as October 2023. That means that every year you pay back 8.125% of your total loan amount. So in year one in this example, that means you will pay $32,500 towards interest. That amount is paid out monthly, so in this example, $2708.33 is going to be paid towards interest every month. (32,500/12)
Well, let’s say rates drop a full percentage (which as of today, mid November 2023, they basically have) and we’re at 7.125% instead of 8.125%. The total interest paid in year one is $28,500. That’s $2375/month. That’s a difference of MORE THAN $300 A MONTH! For many people, this is the difference between affording a home and not affording a home! One percent may not sound like much, but $300/month is a big deal!
One last bit of math
Let’s drive this point home further. Let’s look not only at interest but your entire monthly PITI payment (principal, interest, taxes, insurance). Let’s set that number at $3000/month. At an 8.125% interest rate, a $3000 monthly payment is a $387,000 purchase price (figuring 100% financing). It’s actually like $2998, but that’s close enough. Anyway, at a 7.125% rate, that same monthly payment allows you to finance roughly $426,000, which is nearly $40,000 MORE than at 8.125%!
Let’s spell that out in it’s own line here…factoring the average home value in my area, this difference of 1% in my interest rate can increase my budget by FORTY. THOUSAND. DOLLARS.
If you’re somebody who wants to buy a home but you’ve been waiting for affordability to improve before getting out there and starting the process...this is literally the news you’ve been waiting for. LET’S GO!