How Much More Should You Increase Your Home Budget for Higher Interest Rates?

A real estate agent standing in front of a house with a FOR SALE sign in the yard, talking with an African American woman who could be the homeower, or a potential buyer.
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If you’re shopping for a home right now, you’re no doubt aware of two dynamics happening at the same time: Record-high home prices, and rapidly increasing interest rates. If you began your house hunt a few months ago with one budget in mind, you probably need to toss that old budget out and make a new one based on rising purchase and borrowing costs.

In 2022 alone, the rate for a 30-year fixed mortgage has risen to 5.65% from 3.29% at the start of the year, CNBC reported, citing data from Mortgage News Daily. To put those numbers into real dollars, your monthly mortgage payment would be $2,078 if you bought a $450,000 home at the current rate of 5.65% and made a 20% down payment. At a 3.29% rate, your mortgage would have been $1,575 a month — a difference of about $500.

Meanwhile, the typical home value in the United States as of July 8 is $349,816, according to Zillow. That’s up from about $328,000 in January — a gain of nearly $22,000.

So if you began house hunting at the beginning of the year and are still looking for the perfect home, your budget might already have increased by around $20,000 on the purchase price and $500 on the monthly mortgage payment.

Mortgage rates are likely to keep pushing higher this year as the Federal Reserve implements more interest-rate hikes to help tame inflation — a move most economists expect.

About the only positive trend is that home price increases might finally be softening. The most recent S&P CoreLogic Case-Shiller U.S. National Home Price Index, released on June 28, reported a 20.4% year-over-year gain in April 2022, which was down from a 20.6% increase the previous month.

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“April 2022 showed initial (although inconsistent) signs of a deceleration in the growth rate of U.S. home prices,” Craig J. Lazzara, managing director at S&P DJI, said in a statement.

Despite the deceleration in the National Composite and a modest acceleration in the 10- and 20-City Composites, the growth rates are still “extremely strong by historical standards,” he added.

When developing a home budget, many of the old rules still apply even as costs go up. As CNBC noted, a general rule of thumb is that your housing costs should equal about 30% of your income. This should cover the mortgage payment as well as property taxes, homeowners insurance and maintenance. You can probably kick that percentage higher if you don’t have children, or move it lower if you have other burdensome debt such as student loans.

You can also give yourself a little more breathing room by working with lenders to secure the best possible mortgage rate. This partly depends on your credit score. If your score is 740 or above, you can probably get the best advertised rates.

Finally, making a bigger down payment will lower your monthly mortgage payment, which means you can adjust your budget accordingly. But if you can only make the minimum down payment — such as the minimum FHA mortgage down payment of 3.5% — your monthly mortgage payment will be a lot higher.

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