Why One Point Matters

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A lot has been made recently about mortgage interest rates and the trajectory they’re on. After years of historically low rates, they began to climb in May, then dipped again, then went up a bit again. For the moment they appear to be stable, but there’s no telling when the final months of the year will hold for potential homebuyers.

Throughout all this up and down, you may have been wondering: what’s the big deal about a few percentage points? Surely the difference between borrowing at a 4% rate and a 5% rate can’t be that different. In most cases, with most loans, you’d be right. A percentage point or two on an auto loan or a credit card doesn’t make that much of a difference in the borrower’s monthly payments, and therefore isn’t newsworthy.

But mortgages are a totally different beast. The main reason that just extra percentage point tacked onto the interest rate is such a big deal is because most mortgages are for large sums of money, so the dollar amount attached to each percentage point of the interest rate is fairly high. To illustrate this point, let’s use the example of a $200,000 mortgage.

Six months ago, a couple with good credit and a 20% down payment would have qualified for about a 3.8% interest rate. After their $40,000 down payment, the couple would need to borrow $160,000 to purchase the home. At 3.8%, this would make their monthly mortgage payments would be $745.53, assuming a 30-year fixed rate loan.

But let’s say interest rates have risen in such a way that that same couple could expect to pay just one extra percentage point on their mortgage – their 3.8% rate is now a 4.8% rate. Doesn’t sound too bad, right? And historically, 4.8% is a very low mortgage interest rate. But that one additional point will cost the same borrowers with the same mortgage an extra $94 per month. To put that in perspective, if the couple had gotten the lower interest rate and invested the extra $94 per month over the life of their home loan in the stock market, they could expect to have a paid off house and $93,000.

So the takeaway here is that an increase in mortgage interest rates – even just a small one – can have a big impact on what people actually end up paying for their homes. If you’re thinking about buying, it’s a good idea to keep an eye on rates and pounce when the moment is right. You never know when a few measly percentage points could sneak up on you and bust your housing budget.

About Lindsay Meredith

Lindsay is a high school teacher and personal finance blogger. She lives, works, and plays in the Washington, D.C. area.

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