Ask Brian is a weekly column by Real Estate Expert Brian Kline. If you have questions on real estate investing, DIY, home buying/selling, or other housing inquiries please email your questions to [email protected].
Question from Lucas in WV: Hi Brian, We got married as a young couple a little over four years ago with plans to buy our first home as soon as we could. Right now, we are very frustrated. Both of us work and between us, we earn a little more than $150k before taxes, our 401ks, and other withholdings. We both have car payments that total $600 per month and make credit card payments of $350 each month. We’ve been frugal these past four years and have saved a 5% down payment towards a home purchase of around $290,000.
We’ve been looking at houses for almost eight months. There hasn’t been much to look at although we’ve stretched into areas that would have a 45-minute work commute. We’ve had six offers rejected. Our realtor tells us to be patient because more houses are starting to come on the market, and we will probably be able to make a successful bid on a house that we want in the next several weeks or a couple of months. Now, we are watching mortgage rates climb almost every week. I talked to our mortgage broker yesterday and she said to expect to pay an interest rate of at least 6.1% if we find something to lock-in during the next couple of weeks. We think that interest rate is insane. We’re thinking about giving up altogether and using our savings for something else like a big vacation or refurnishing our rental house. Should we give up on buying a house now the interest rates have gotten so high?
Answer: Hello Lucas. I don’t think you should be thinking about giving up at all. I think you should keep everything in perspective. Yes, interest rates are going up. But that is why you are more likely to find the house that you want and have an offer accepted. It’s unfortunate for others that are being priced out of the market by higher interest rates but that is expected to stabilize prices and make more houses available to the people that can still qualify. More or less, you are trading a higher interest rate for rising house prices that have been skyrocketing for a couple of years. Interest rates might go a little higher but not at the rate houses have gone up. It should become a more stable market.
Based on the price range that you are looking to buy in, you should be looking at a mortgage payment of around $1,850 per month. That includes the principal, interest, property taxes, and insurance. Using that and a rough calculation of your finances, I looked at how affordable a house should be for you.
There are a couple of different models that mortgage companies suggest that you use to determine the size of the mortgage payment that you can comfortably afford. In fact, they will probably require you to meet at least one of these models. I’m thinking that your mortgage broker has explained part of this to you as to how she is qualifying you for a mortgage. One model is a mortgage payment that is 28% of your gross monthly take-home pay. With a $150,000 annual income, your gross monthly income should be about $12,500. Twenty-eight percent of that is $3,500. Because you are looking at a mortgage payment of $1,850, you shouldn’t have any trouble qualifying at 6.1%. In that calculation, I didn’t include your 401k withholding but if you are withholding 8%, that comes to $1000 per month and you would still easily qualify.
Another model is that your total monthly debt, including your mortgage payment, shouldn't be more than 45% of your after-tax income. In this one, I used the 8% 401k withholding (although you didn’t say how much it is). Based on that and the other debts you mentioned your monthly debt (including 401k) should come to about $6,600. That is well within 45% of your after-tax income which should be about $9,690.
Lucas, you will want to talk with your mortgage broker again but both models say you are well qualified for a $290,000 home based on 5% down, 6.1% interest, and your current income. If you want to try the third model, it is your total monthly debt, including your mortgage payment, shouldn't be more than 35% of your pre-tax income.
However, your basic question is should you buy a home with interest rates as high as they are? I think you need to keep today’s interest rates in perspective. Too much emphasis is being placed on modestly rising interest rates. Keep in mind that during the pandemic, mortgage rates hit historic lows that dipped as low as 2.65% in January 2021. Many people remember the 18% mortgage rates of the 1980s -- or even an 8% during the 1990s. We didn’t even see 6% 30-year mortgages until 2002. Historically, people would probably say today’s 6% is a good mortgage rate. However, someone who bought a home last year at 2.65% might not think 6% is a good rate today.
Interest rates are going higher because the Federal Reserve is trying to slow down inflation and the best forecast is that won’t be achieved until some time next year. Until we see sustained evidence of inflation pressures moderating, the risk is toward higher mortgage rates. That means locking in today at about 6% will be better than what is expected for the next year, and we don’t know what to expect beyond next year. Lucas, if you’re not sure whether or not you want to continue renting or buy right now, it’s better to make your decision based on your personal situation and your personal needs. Think about where you are in your life. You can also use online calculators to help you make a financial determination between renting and buying.
What advice do you have for home buyers as interest rates go up? Please leave a comment.
Our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions or inquiries to [email protected].