I’m hoping to buy a home next year, and watching the current market has been very depressing. You might think I’d be feeling optimistic about the possibility of at least getting a good price on a house. After all, according to the S&P CoreLogic Case-Shiller National Home Price Index, home prices fell by almost 0.5% between May 2022 and May 2023. As reported by Business Insider, this was the biggest year-over-year drop since way back in 2012.
Unfortunately, mortgage rates are making homes less affordable than ever. Let’s take a look at the impact of higher mortgage rates on the costs of buying a home.
What can a 7% mortgage do for you?
Since very few of us can actually expect to pay for a home outright, many people rely on a mortgage loan to fund a home purchase. But these days, contemplating the cost of doing so isn’t for the faint of heart. I turned to The Ascent’s mortgage calculator to get a look at the differences between buying with a 3% mortgage, which you might have scored if you’d bought at the end of 2021, versus buying with one at 6.96% — the average rate on a 30-year fixed-rate mortgage loan as of this writing, according to Freddie Mac. The results aren’t pretty.
Let’s say you were planning to buy a $250,000 home with 10% down. You’d be taking out a mortgage for $225,000 ($250,000 minus a down payment of $25,000). If you managed to snag a 3% rate for a 30-year loan, your monthly payment (including just principal and interest, along with PMI) would come out to $1,046. Not too bad!
But what if you wanted to buy the same house with the same down payment, and your mortgage rate is 6.96%? In this instance, your monthly cost for principal and interest (and PMI, or private mortgage insurance, which you’ll be required to pay when you buy with a conventional loan and a down payment less than 20%) comes to $1,637. That’s a bump of nearly $600 more per month. It’s easy to see how homes are less affordable than ever, even as prices drop overall.
How can you get ready to buy?
I hope I haven’t burst your bubble regarding how affordable it is to buy a home right now, but it’s important to acknowledge reality and make a plan to cope. Remember, knowledge is power. It doesn’t seem likely that mortgage rates will suddenly fall, either.
So here are a few moves you can make to ensure that when the time is right, you can get the best deal possible on a mortgage — even if that deal is far less impressive than what you might’ve snagged had you bought in 2019, 2020, or 2021.
Save, save, and save some more
The larger the sum you can put down to buy a house, the less you will have to finance with a mortgage loan and the less interest you’ll pay. You’ll also spare yourself the cost of PMI if you’re buying with a conventional loan and can put at least 20% down.
I’m hesitant to recommend cutting your spending to the bone, because you should also be able to live your life. So what I recommend instead is asking for a raise at work, picking up a side hustle, or changing jobs altogether. Never underestimate the potential impact of a higher income on your finances. And owning a home is expensive, so give yourself the best chance of success.
Whip your credit into shape
Your credit score is important for many aspects of your financial life, and this is especially true for borrowing a large sum of money in the form of a mortgage loan. The better your credit score, the more likely you are to snag the best rate available at the time you apply (which, let’s be real, will still be higher than you want in this current market).
How do you increase your credit score? Well, try paying down existing debt, committing to making all your payments on time, and going through your credit report to look for errors you can have removed. And exercise patience!
When it’s time to buy, don’t just go with the first mortgage lender you talk to. Apply for pre-approval with a few, and see what kind of rates you can get. Shopping around is one of the best ways to save money, and it’s crucial that you save as much as possible when making a many-year commitment to a home purchase.
It’s rough out there, but don’t lose hope. Keep working on your finances while you wait for the right time to buy.