The Fed recently announced they would continue their current pace of purchasing bonds until the economy was stronger. This bond purchasing program is the reason that mortgage interest rates are at historic lows. Rates began to increase over the last several months just on the anticipation that the Fed would announce that they would be reducing the level of bond purchases last month. When that didn’t happen, rates actually decreased (4.50 to 4.37).
That was great news for any buyer in the process of purchasing a home. However, this window of opportunity is expected to close in the very near future as most experts expect the Fed to taper the bond purchasers in December. Even Ben Bernanke, Chairman of the Fed, suggested that the Fed could still scale back the stimulus this year. He stated:
"If the data confirms our basic outlook, then we could move later this year.”
Where will mortgage rates head in 2014?
The Mortgage Bankers Association, Fannie Mae, Freddie Mac and the National Association of Realtors have each projected that the 30 year fixed rate mortgage will have interest rates in excess of 5% by this time next year. The average of their four projections is 5.3%. The table below shows the impact this will have on the monthly principal and interest payment on a $250,000 mortgage:
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Last week, Bernard Bernanke startled many by announcing that the Fed will not wind down their bond buying program right now. The program is part of an overall stimulus package geared at bringing back the national economy. The Fed’s purchase of these bonds over the last few years has driven mortgage rates to historic lows. The assumption that there would be a reduction in bond purchases has caused 30 year mortgage rates to spike upward over the last few months.
Surprisingly, Bernanke revealed the Fed will continue bond purchasers at the current pace. What happened and what does it mean to mortgage interest rates?
What would have happened if they reduced bond purchases?
According to Bankrate.com:
“The Fed could have caused rates to shoot up this week if it had announced the tapering of its bond-purchasing program.”
Why did the Fed decide not to start winding down bond purchases?
Moody’s Analytics reported that there were three reasons:
- Subpar economic data
- Tighter financial conditions
- Uncertainty surrounding fiscal policy
What does this mean to a buyer applying for a mortgage?
Those at Bankrate.com explain:
“For now, borrowers have dodged another spike in rates. The Fed’s announcement might even cause rates to drop in coming days, says Paul Edelstein, director of financial economics at IHS Global Insight.
‘Mortgage rates should fall back — not massively, but to some extent,’ he says.
That doesn’t mean homebuyers and homeowners should wait for lower rates, mortgage professionals say.
Eventually, once the Fed lets the mortgage market and the economy start walking on their own, rates will probably head back to the 5 percent or 6 percent range, says Scott Schang, manager for Broadview Mortgage Katella in Orange, Calif.”
When will the Fed begin winding down bond purchases?
According to an article in the Wall Street Journal:
“Federal Reserve policy makers decided this week that the economy isn’t in the right place for them to start winding down their bond-buying program. By the time they meet in December, it might be.
The decision to not start winding down the bond-buying program now was close… The economy only needs to get a little bit better over the next few months for the central bank to get its nerve back. That should be an easy bar for the economy to clear.”
Bernanke himself has not ruled out that the Fed could still scale back the stimulus this year. He stated:
“If the data confirms our basic outlook, then we could move later this year.”
Ed Conarchy, a mortgage planner at Cherry Creek Mortgage in Gurnee, IL had a great quote in the Bankrate article:
“Remember that rates go up like a rocket and fall like a feather.”
Still, Bankrate.com itself probably put it best: Grab the gift before it’s gone!
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If you’re in the market for a new home, chances are you’ll have to compromise at some point along the way. Maybe you’ll have to commute a little farther than you’d like in order to get the best value for your money. Or perhaps you’ll forgo a huge backyard to be closer to the city.
And when it comes to finances, you might find a disparity between how much house you want and how much house you can purchase given your gross monthly income and other factors.
Home loans are made against your ability to repay. While the mortgage loan is secured against the house, it is really made against your income. That’s what mortgage lenders look for — income to offset liabilities.
Simply put, the amount of income you need to purchase a house will vary by your payment comfort level, including any other monthly debt obligations you might have.
Mortgage payment: Principal, interest, property taxes insurance and mortgage insurance, if needed
Consumer debts: Minimum payment obligations on things such as auto loans, credit cards, student loans, personal loans and installment loans
Other debt obligations: Alimony and/or child support or any other court-ordered repayment obligations
Running the math
Here’s a simple formula to calculate the amount of income you’ll need to purchase a home:
Target mortgage payment + consumer debts ÷ .36 = Gross monthly income needed to qualify
Most lenders limit your debt-to-income ratio (how much of your monthly income pays debt) to between 36 percent and 45 percent. While the exact ratio varies by lender and loan type, it’s best to base your calculations on the lower end to ensure that you won’t overextend yourself financially.
So, if your target mortgage payment is $2,000 per month and you have consumer debts of $300 per month, you will need $6,388 gross monthly income to offset your housing expenses and consumer obligations.
Your down payment is another important factor in determining how much income you’ll need to buy a home.
Consider the following loan scenario using a purchase price of $300,000 (assuming no other debts) and the current rates on Zillow Mortgage Marketplace.
- Down payment: 5 percent ($15,000)
- Interest rate: 3.26 percent
- Approximate mortgage payment: $1,770
- Gross monthly income needed: $4,916
So at the end of the day how much income you need to purchase a home is predicated on your monthly income, consumer debt obligations and down payment.
Impact of debt
For every dollar of debt, you will need double that in income. So if you have a $300 car payment, you’ll need at least $600 per month or more in income to offset that debt.
Debt erodes income, and less income translates to less purchasing power.
So, does buying a home make sense?
Yes, so long as the amount you can borrow for your desired purchase price is in sync with your debt obligations and, of course, your down payment.
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Scott Sheldon is a senior loan officer and consumer advocate based in Santa Rosa, California. Scott has been seen in Yahoo! Homes, CNN Money, Marketwatch and The Wall Street Journal. Connect with him at Sonoma County Mortgages.
Note: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinion or position of Zillow.