We are living in a time of extremely low interest rates.  Mortgage loans at 3% or 4% fixed over 30 years are the norm, and have been for the past 5 years.

Most of us don’t remember the 90’s when we considered 6% and 7% as  “low” interest rates. You may still have a loan from that era, if you did not refinance yet.

And you certainly won’t remember the 1980’s when many people paid 20% interest for mortgages and considered 12% a bargain.

Why Should We Remember the Old Times?

Most buyers don’t have enough cash to buy a home outright.  They finance their purchase with a 15 or 30 year bank loan. It is important for them to understand how interest rates effect the affordability of homes.

Interest rates determine your monthly mortgage payment. The lower the interest rate, the lower you monthly payment. That’s exactly why many home owners race to the bank to refinance when interest rates drop by 1% or 2%.

On the other hand, if you can afford a certain monthly payment, then a lower interest rate allows you to borrow more money. This means that you can afford a more expensive home.

The Impact of Interest Rates on Buying Power

The chart at the top of this post shows how large the impact of interest changes is on your buying power. It assumes that you can spend $1,100 a month on principal and interest and that you have a 10% down payment.

Currently, interest rates are around 3.3%, which means you could buy a $280,000 property and only pay $1,100 a month.

Let’s assume interest rates would go up to 7%. That’s the level most of us paid between 2000 and 2005. You could buy a $180,000 home for your $1,100 monthly payment. This means the affordability has decreased by $100,000. This is 35.7% less than you can afford today.

Another hike in interest rates to 10% would lower the affordability by another $40,000. You would have to settle for a $120,000 home for sale.

Who Is Affected?

You are not the only one that would feel the impact of higher interest rates. Our whole economy would suffer, because home buyers could no longer afford today’s average property.

This would most likely cause another recession. It would substantially depress home values, way below what we have experienced during the past 5 years.

The Good News

The Federal Reserve has promised to keep the prime lending rates close to 0% until the unemployment rate drops below 6.5%. Experts estimate that this may take another 3 years.

So, here is your chance to buy a great home at the lowest interest you will most likely see in your life time. Lock it in for 30 years and you will be set for a long time.