Your Borrowing Power and Mortgage Rates…

By Betsy Falwell

How much can I borrow? It’s the first question most home buyers ask when shopping around for a home loan. I know it’s the first question I asked when I visited my mortgage broker a few months ago. And while it may seem like it should be a simple question with an equally simple answer, the reality is that the answer to “How much can I borrow?” is far from a static one.

Your Borrowing Power and Mortgage Rates

You’d think that if you went to the bank today and applied for a home loan, then did the same thing three months from now, that your borrowing power wouldn’t change all that month. After all, your job hasn’t changed, so why should your home loan status?

That, however, is not the case. The amount of money you’ll be able to borrow from a lender varies depending on current mortgage rates. In other words, when mortgage rates are up, you’ll be able to borrow less; when mortgage rates are down, your borrowing power will move in the opposite direction.

Why Mortgage Rates Matter

Why do changing mortgage rates matter so much? Because, as they affect your borrowing power – and, hence, your monthly payments – they also affect your debt-to-income (DTI) ratios. These ratios (there are two of them) are key to determining how much mortgage you can afford. Most lenders are looking for a front-end DTI ratio, which compares your housing-related debt to your gross income, between 28 and 33 percent. They want to see a back-end DTI, which compares your overall monthly debt to your gross monthly income, between 36 and 41 percent. If climbing mortgage rates send your monthly mortgage payments higher, that’ll also increase your DTI ratios – and decrease your buying power.

Real-Life Examples

I learned this firsthand when my husband and I first started applying for a mortgage for our new home. We went to see our mortgage broker for the first time when we put our current house on the market. Anticipating a quick sale, we wanted to have the mortgage application process underway as soon as possible. Mortgage rates were exceptionally low, and we wanted to capitalize on that.

But when our house didn’t sell during the 60-day rate-lock period, we once again had to ask “How much can I borrow?”  This time, the answer was markedly different. During the intervening two months, mortgage rates had inched up – not a dramatic leap, but enough to make a sizeable difference to our borrowing power. With a gross monthly income of $4500, we were limited to a monthly mortgage cost (including escrow) of $1500 based on our front-end DTI, and a limit of $1705 based on our back-end DTI: Here’s how changing mortgage rates affected us:

  • February loan application (mortgage rates: 3.75% on a 30-year fixed): Maximum mortgage – $305,000 with a 20% down payment, or a loan value of $244,000
  • April loan application (mortgage rates: 4.25% on a 30-year fixed): Maximum mortgage – $285,000 with a 20% down payment, or a loan value of $228,000

Essentially, that half-a-percentage point difference in mortgage rates between February and April cost us $20,000 in borrowing power.

What Determines Mortgage Rates

Whether you go through a mortgage broker, a bank, or an online lender, all mortgage rates depend essentially on two main things: market factors and personal factors.

Market factors include everything from inflation to the Federal Reserve’s interest rates and T-bond yields to mortgage-backed securities. These factors affect everyone similarly. Personal factors, on the other hand, depend on elements that vary from person to person. They include:

  • Your credit score
  • Your loan amount
  • The size of your down payment
  • The location of the property you wish to buy
  • The term of your mortgage (whether you want a 30-year fixed or a 5/1 ARM)
  • Your DTI ratios

There are more, but these are some of the biggest factors that cause mortgage rates to change from customer to customer.