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Mortgage interest rates have been declining for the last 2 years. There is indirect relationship between the interest rate and home affordability. As rates decrease, the among of money one can borrow increases. With a significant decline in rates, home buyers can borrow more while keeping the monthly payments the same. 

Mortgage rates have been in decline since October 2018 until September 2020. On October 11, 2018, the 30-year fixed mortgage rate was 4.9% on average in the United States, according to the Federal Reserve Bank of St. Louis data. As of September 10, 2020, this rate has declined to 2.86%, according to the Fed data. This represents a decline by more than 41% in just 2 years.   

For home buyers lower interest rates increase home affordability. As rates decline, the amount of money one can borrow increases while the monthly payments stay the same. Now, let’s analyze how much more home the buyer can afford due to the decline in interest rates.  

I have four hypothetical home buyers with monthly budgets of $1,000; $2,000; $3,000 and $4,000 that will go towards paying for 30-year fixed rate mortgage. These monthly payments are principal and interest on the 30-year fixed mortgage. Homeowners may be required to pay additional property tax and HOA expenses that I do not include in my calculations as they are very exclusive to each property and location. How much more money can one borrow due to the decline in rates from 4.9% in October 2018 to 2.86% in September 2020? 

The first buyer has $1000 monthly budget towards the mortgage payments. He or she was able to borrow $188,421 in October 2018 when interest rate was 4.9%. However, with the decline in rates from 4.9% to 2.86%, the same home buyer can now borrow $241,493. In other words, the home buyer with $1000 monthly budget can now borrow an additional $53,072 due to the decline in interest rates (see Chart 1). The monthly payments will remain the same at $1000 per month but the amount available to borrow increased significantly by more than $53,000 in just two years. 

The second home buyer has the budget of $2,000 per month to spend on the 30-year fixed mortgage. This home buyer was able to borrow $376,842 for a home in October 2018 when the interest rate was 4.9%. With the decline in the interest rates from 4.9% to 2.86%, he/she can now borrow $482,985 and pay the same $2,000 per month. This translates into the increase of $106,143 in purchasing power (see Chart 2). 

The third home buyer with the budget of $3,000 per month was able to borrow $565,263 in October 2018. However, as rates declined from 4.9% to 2.86% the amount available to borrow increased by $159,215 in just two years (see Chart 3). This home buyer can now borrow $724,478 and pay the same $3,000 per month. 

The fourth home buyer had the biggest nominal gain from the decline in rates. With the monthly budget of $4,000, the fourth home buyer was able to borrow $753,684 in October 2018 when the interest rate was 4.9%. Due to decline in rates from 4.9% to 2.86%, this home buyer can now borrow an extra $212,287 (see Chart 4). The fourth home buyer can now borrow a staggering $965,971 with the same $4,000 a month budget. 

In percentage terms, each home buyer was able to borrow an extra 28% in September 2020 and keep monthly payments the same vs. two years ago. Lower interest rates allow home buyers to borrow more keeping monthly payments the same. This improves home affordability. 

Who else might benefit from lower mortgage rates? 

• For existing home buyers, low interest rates may provide opportunity to refinance and lower monthly payments. Lower interest rates can reduce home expenses for both home buyers and homeowners. Mortgage payments are significant part of many Americans monthly budget. Lower mortgage rate can provide opportunity to refinance for existing homeowners. Homeowners can reduce monthly mortgage payments and generate extra savings each month. 
• Home builders are also beneficiary of lower interest rates. As home buyers can now afford to borrow more, home builders will be able to sell more expensive homes. Also, first time home buyers can now afford to borrow more due to lower rates. With increased borrowing power, new home buyers will be able to afford a more expensive new home.   
• Lower interest rates create demand for mortgage refinancing as well as home purchases. Finance companies that service mortgages, mortgage brokers that create and sell mortgages, real estate agents who work with home buyers will also benefit from the increased demand for houses. 
• A healthy housing market will also spill its benefits on furniture stores, home improvement stores, and landscaping companies.
• Local governments will also benefit from a strong housing market. Each new home built and sold provides tax revenues for local governments.  

Data: 

Federal Reserve Bank of St. Louis. Data accessed on September 19, 2020 https://fred.stlouisfed.org/graph/?g=NUh

Disclosures: 

The available mortgage interest rate is based on individual credit history, debt to income ratio and other factors that are very custom to each person. The analysis in this paper is based on 30-Year Fixed Rate Mortgage Average in the United States, Percent, Weekly, Not Seasonally Adjusted. The interest rate available to you maybe lower or higher based on where you live and on your personal financial situation. 

The analysis is based on historical data and future expectations that may not be correct. This paper was written as an opinion only. The data is not guaranteed to be accurate or complete. Please consult with your financial advisor and real estate agent, before making an investment decision. Neither ECNFIN.COM nor its author are responsible for any damages or losses arising from any use of this information.

ECNFIN.com and its podcast are not associated with nor do they necessarily represent the opinion or advice of Epiqwest Culver Wealth Advisors LLC.  Past performance doesn’t guarantee future results. 

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Tags: decline in rates and ability to borrow more, housing affordability, how much mortgage one can afford, interest rates and mortgage, mortgage rates