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It was a tough 2020 for most people across the country. Jobs were lost or changed. Budgets were stretched. Kids are being taught at home, changing our lives and the way we live in our home. The good news is we have a vaccine. 2021 is showing lots of promise that we may get COVID-19 under control. That’s the good news! But the bad news is that when the pandemic subsides, the economy is expected to take off again. That can mean inflation. When that happens, interest rates will rise to keep the economy in check. That means bad news for home buyers. That is especially important because housing materials costs increased dramatically 2020. But that was hidden because of low-interest rates and buyers buying on payment, not house price. That all may change and change quickly in 2021.
What Else Did COVID-19 Change in For Us and Our Homes?
Over the last 20+ years the trend in home construction has been to create open floor plans and reduce redundancy. Gone are the living room AND family room. We just have a great room now. We no longer have a kitchen table and a formal dining room. We just have a single dining area and perhaps a bar with chairs. While we eliminated the wasted space and lots of walls to create open areas, we inadvertently got rid of all of the private areas of the home (with the exception of the bedroom).
Now comes COVID-19 and stay at home orders. Adults had to work from home, and kids had to “go to school” from home. Now we are all doing functions that require focus and quiet with no place in the home to do that individually (and it’s no fun being in your bedroom 24 hours a day). So, home plans will be changing. They are changing. Dens, home offices, separate dining areas, study nooks/rooms… all of these are now appearing in home plans. Will these new work from home edicts continue? Employers are saving lots of money when they don’t have to provide office space. We’ll see what the future holds in store.
Interest Rate Increases, the Silent Dream Killer
At first, it will begin happening, and you won’t even know it. The silent increase in home mortgage rates will begin impacting your new custom home. If you are purchasing a home and you need a mortgage to do it, every interest rate increase means you qualify for a lower loan amount. This means you will make the exact same payment, but that payment will buy a smaller home or one with fewer amenities. Every time the rate goes up, just a .25% means you could have lost the ability to get the mudroom you have always wanted or the granite countertop you have dreamed about.
Did you know that house prices went up, on average in 2020, 15%? That’s right, 2020 saw house prices skyrocket. But it also saw the lowest interest rates in history. Most homebuyers that are financing a home aren’t buying a home based on home cost. They are buying it based on what their lender said they could afford in payment. When something is at the bottom, it has nowhere to go but up. Let’s talk about how a rise in interest rates coupled with the rise in housing costs will impact your new home.
Determining Your Maximum Loan Amount
Many home buyers have the lending process backward. They approach a custom home builder and request an estimate or quote to take to the bank. They want to see if they will qualify for the house they have selected. That is actually backward. The first step for a home buyer is to actually go to the mortgage lender first! A lender just doesn’t arbitrarily pick an amount and approve you for it, there are many criteria that go into determining the maximum amount you will quality for and the interest rate you will be charged.
A lender makes money by loaning money. Lending money to someone that won’t pay it back defeats that purpose. Lenders have a process to determine how much of a loan payment you can reasonably make each month based on your income and your other debts and then be expected to regularly make that payment on time. This is known as your debt-to-income ratio.
Underwriters look at your “front-end” ratio and your “back-end” ratio. The front-end ratio is your new mortgage payment (principal, interest, property taxes, and insurance, plus other items like home owner dues if applicable) divided by your gross monthly income. So if your monthly income is $8,000 and your total house payment is $2,000, your front-end ratio is 25%.
Add your other monthly expenses, car payments that total $600 and $200 in credit card payments, to your housing costs for a total of $2,800 a month, and you have a back end ratio of 35%. This falls within most lender’s guidelines, assuming that you have good credit and some money in the bank.
How Increasing Interest Rates Decreases the House You Can Afford
If your lender says that based on your income and debts (debt-to-income ratio) you will qualify for a monthly payment of $1,200. That is the maximum they will allow you to pay for your housing costs. But there are several other factors that determine how much money you can spend on buying your new home. They include the interest rate you will be charged, the term (or duration) of the loan, how much down payment money you have, along with some other items.
So, let’s say that you qualify for a Principal & Interest (P&I) monthly payment of $1,100 (using only P & I to illustrate – taxes, homeowner’s insurance, and mortgage insurance are not included).
Sales Price of $335,000
$1,094 per month
20 percent down payment
Loan amount of $268,000
2.5% interest rate
So, what happens with a 1% increase in the interest rate?
Same scenario — but the rate is now 3.75%. The maximum sales price decreases to $293,750. With 20% down payment, the loan amount is now $41,250 or more than a 12% decrease in homebuyer purchasing power.
So, here is the bottom line – For every .5% (one-half) percent increase in interest rate, your purchasing power may be decreased by about 4 to 5 percent (the percentage is smaller for lower loan amounts). For every 1 percent interest rate increase, your purchasing power may be decreased by about 9 to 11 percent (the percentage is smaller for lower loan amounts).
Interest rates are at their lowest levels ever!. Who knows when they will increase. We just know that they have nowhere to go but up. Even if they rise just .5 – 1%, that is still a historically good rate. However, given current rates, that would mean your actual home purchasing power would decrease by 10-15%. That significantly impacts the home the lender will say you can afford!
The Value of Modular
Interest rates will go up. When that happens, the amount of home you can purchase will go down. The one thing that remains constant is the value that modular construction provides when building your custom home. The construction labor shortage is continuing to put pressure on home prices. Material costs have surged and continue to rise. As home prices rise along with interest rates, the custom home you can afford to build will decrease and decrease rapidly with rising interest rates. Modular construction is the modern way to get the home you want at the absolute best value!
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