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When Mortgage Rates Rise 1%, Your Purchasing Power Falls By 10.75%

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Home Affordability Is Driven By Mortgage Rates

“Have you talked to a lender about how much home you can afford?”

If you’ve ever bought a home, no doubt your REALTOR® asked you that question, or you wondered it to yourself. It’s the starting point for practically every home search in this country.

It’s a variant of “For how much home have you been pre-approved to buy?”

These questions — although rote for REALTORS® — serve an important purpose for buyers. (1) They put boundaries on your home search, and (2) They establish a price range for the homes in which you can actually afford to live.

They also put undue focus on “purchase price” as the key variable in home affordability.

Purchase price has less to do with home affordability than you think.

The real key to home affordability is mortgage rates.

1% Rate Change = 10.75% Purchasing Power Change

Mortgage rates have more influence on home affordability than home prices.

If that seems strange to you, think about Q1 2011. Home affordability made all-time records that quarter. It wasn’t that home prices were suddenly lower than ever before. It’s that mortgage rates were. With each tick lower for rates, purchasing power increased.

The math works in reverse, too. Rising mortgage rates harm affordability.

Click here to get a mortgage rate quote.

As an it-could-happen-to-anyone example, a home buyer in the Washington, DC metro area is pre-approved at today’s rates for a maximum $600,000 home, assuming 20 percent down. This is his “purchasing power”.

  • The buyer shops for homes, armed with a $600,000 pre-approval.
  • While he shops, mortgage rates are rising. They rise by 1 percentage point.
  • The buyer finds a home for $600,000 and submits a bid.

Next, the buyer’s loan is denied by the lender. Rising mortgage rates zapped his purchasing power. For each 0.125% increase to mortgage rates, his maximum allowable purchase price fell 1.35 percent.

“How much home can I afford?” he asks the lender. Not $600,000, comes the reply.

“Today, you can afford $535,000.”

October 1 Changes In Purchasing Power

The above example is somewhat extreme.

It’s rare for rates to rise by a percentage point during the amount of time most people need to find and buy a home. We used the Washington, DC metro area as an example, though, for a reason.

Washington, DC and its surrounding regions are part of the government’s “High Cost” areas for home loans. The local conforming loan limit is $729,750.

After September, those limits change.

Starting October 1, 2011, in places like Loudoun County, Virginia; Arlington, Virginia; and, Montgomery County, Maryland, local conforming loan limits will be lowered $625,500, rendering loans in excess of that amount “jumbo”.

Mortgage rates on jumbo loans are often 1 point higher than for comparable conforming loans — and sometimes more. This means that, starting October 1, 2011, anyone whose mortgage will be “jumbo” will find themselves with 10.75% less purchasing power at least.

October is less than 3 months away.

Get Today’s Mortgage Rates And Stay “Pre-Approved”

Pre-approvals are helpful, but they’re just a snapshot in time. The answer to “How much home can I afford?” is proven to be different every single day.

You’ll see what rates are doing, and you’ll get a feel for how your purchasing power has changed since you first applied for a home loan.

Mortgage rates are off their best levels of the year. As they keep rising, your purchasing power will fall.

8 Ways To Accidentally “Un-Approve” Your Mortgage

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For all the talk of how tough it can be to get approved lately, the basics haven’t changed. Mortgage approvals are still a 3-legged stool of income, equity, and credit.

Have them in balance, and all else is good.

But, it’s not always getting the mortgage approved that’s hard. Sometimes, it’s keeping the mortgage approved. You have to watch out for landmines.

Foreclosures Add “Approval Risk”

In today’s market, mortgage approvals can be split into 2 groups.

The first group is those whose mortgages are reviewed and approved by just one bank — in this case, the end-lender. It encompasses “traditional” purchases and refinances; ones that don’t require third-party approval or sign-off.

Most mortgages meet this definition.

The other group of mortgage approvals does requires third-party sign-off — often by the existing lender. Distressed property sales and short refis are two such examples.

Fundamentally, the mortgage approval process is the same between the two groups. The major difference is the physical sign-off by a third-party, and that’s where home buyers can get trapped.

While Waiting For An Approval, Time Is Your Enemy

It could take up to 6 months to get to the closing table on a short sale or foreclosure depending on the speed of home appraisal, the amount of time required for bank sign-off, and other random factors (i.e. vacation time, furlough, miscommunications).

During those 6 months, a lot can happen.

You could lose your job, you could get sick, your home could be damaged by a storm. These are things beyond your control, but within the realm of possibility. Each could negate your mortgage approval, thereby kiboshing your deal and, potentially, resulting in the forfeiture of your earnest money.

The longer it takes to close, the more chance for catastrophe, of course. It’s one of the reasons why buying bank-owned homes can be risky.

But beyond the things you can’t control, there are things you can control. Mortgage approvals are fragile, living things and nothing’s done until it’s done.

Good behavior matters.

With that in mind, here are 8 things you should absolutely not do between the date of application and the date of funding.  I’ve been doing this long enough that I can say with certainty: Ignore these rules at your own peril.

Bad Mortgage Behavior, Defined

  1. Don’t buy a new car or trade-up to a bigger lease
  2. Don’t quit your job to change industries or start a new company
  3. Don’t switch from a salaried job to a heavily-commissioned job
  4. Don’t transfer large sums of money between bank accounts
  5. Don’t forget to pay your bills — even the ones in dispute
  6. Don’t open new credit cards — even if you’re getting 20% off
  7. Don’t accept a cash gift without filing the proper “gift” paperwork
  8. Don’t make random, undocumented deposits into your bank account

Now, it may be impractical to have follow every rule to the letter.  I know that.  For example, if your car lease is expiring,  you have to do what you have to do.  But before renewing the lease, check with your loan officer to see if renting a car for the short-term might be a more mortgage-friendly solution instead.

The same goes for accepting cash gifts from parents.  There’s a right way and a wrong way to accept a cash gift and, if you do it the “wrong way”, you may not get to use the gift as part of your down payment funds.

There are a bevy of “gotchas” in Mortgageland and you can’t expect to know them all. These 8 rules, however, are a good start.

Home Buying First Steps: Getting a Pre-Approval Letter

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Before you seriously begin your search to buy a new home it is best to arm yourself with a lender Pre-Approval letter. Why ‘guesstimate’ how much you can afford to pay for a home when you can know exactly how much financing you can obtain from a given lender. Keep in mind that a Pre-Approval is different from a Pre-Qualification. A Pre-Qualification requires no fact checking or verifying of information. A Lender Pre-Approval involves verification of your credit, employment, and financial information. It is a much stronger tool in negotiating an offer to buy a home. It also signals to your real estate agent that you are a well-qualified and serious buyer. A real estate agent will work harder on your behalf knowing that you are pre-approved.

If you would like a Pre-Approval letter to begin your search for a new home call us at 800-511-3330 and a Loan Officer from Acre Mortgage & Financial will get you started.

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