Mortgages Going Up, Can I Qualify?

Definition of "Mortgages going up, can I qualify?"

Tracy  Dombek real estate agent

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Tracy Dombekelite badge icon

Compass RE

Mortgage interest rates were constantly growing last year. And although they faced a recent drop, rates remain above 5% and could increase in the upcoming months.


Higher rates could significantly impact mortgage costs. But they could also have other negative consequences for prospective home-buyers.


Over the past two years, interest rates have increased from historical lows to 7% for 30-year fixed-rate mortgages. Interest rates remain elevated at levels that haven’t been seen for almost 20 years. As a result, the monthly payments have increased, and the debt-to-income ratios are higher.


Concerning the increasing mortgage interest rates, financial institutions are providing alternative financing options that may offer opportunities for buyers to access lower rates in this high-interest rate environment. Providers may also offer cash-out refinances that can be costly to customers when they replace an existing low-interest-rate mortgage with one at a higher current rate. Considering one of these mortgage types, you’ll want to take a second look to understand the risks and whether it meets your needs.


Why is it harder to qualify for a loan with higher interest rates?


Higher rates will make obtaining a loan more difficult because of the lender's limitations on how high your monthly installments can be related to your earnings. When interest rates are higher, your monthly installments also increase.


Most lending institutions check two aspects when approving your loan and establishing your interest rate. They refer to the front-end debt-to-income ratio and the back-end debt-to-income ratio. The first is related to your housing costs compared to your total monthly income, while the last analyzes your debt relative to your gross earnings.


Usually, lenders use the 28/36 rule when applying these ratios. It means your housing costs, including your mortgage interest, can’t be more than 28% of your revenue. Also, all your debts can’t be higher than 36%.


Some exceptions may be allowed, but you don’t want to exceed these numbers to obtain the best deals. So, the chances of your loan being approved will increase.


When interest rates rise, monthly installments also increase, making it more difficult for buyers to stick to the 28/36 rule. For example, an additional  $200 to your monthly installment might exceed the acceptable limit that you can borrow.


When applying for a loan, you should consider these aspects, mainly if you are a first-time home buyer and unfamiliar with the procedure. Also, you should check whether you meet all the requirements to apply for a mortgage. 

How can you deal with this situation?


The most straightforward solution to ensuring you still afford a mortgage is to borrow less. If you apply for a smaller loan, your monthly payment will be smaller. In this way, you will pay less interest and principal each month, so despite your higher rate, you will still keep your debt-to-income ratios within acceptable limits.


Borrowing less means buying a less expensive house or making a more significant downpayment. Both options can be an excellent way to ensure the higher rates don’t affect your home purchase.


Other alternatives include searching for mortgages accessible to you, mainly if you are a first-time home buyer. Some government-backed loans are inclined to have higher debt-to-income ratios. And adjustable-rate mortgages may have lower starting interest rates than fixed-rate loans, which would reduce monthly payments to an amount within limits.

There’s a drawback to this solution. Government-backed loans are prone to high fees, and adjustable-rate mortgages are insecure because your monthly payments could increase over time since your interest rate can adjust. While it may be enticing to explore these options, if you’re finding it hard to qualify for a home, you should avoid them. It would mean you have to wait for a while to buy a house or search for a less expensive property to obtain a fixed-rate loan quickly. Also, a good idea might be to check the real estate market trends for 2023 to make an informed decision when applying for a loan.

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