Right now, mortgage interest rates are very low. At around 4.5%, they're near the bottom hit during the recession. But as explained in an earlier post, they'll have to rise eventually and may begin to climb sooner than later. That will dampen Americans' purchasing power when buying a home. But how much could rising rates affect the price of the home you can afford?

The chart below gives you some idea of how changing rates affect the mortgage balance you can afford based on different monthly payment amounts:

mortgage interest rates purchasing power.png

For example, the red line provides the path of mortgage affordability as rates rise if you can afford to pay $1,000 per month. Right now, you could afford a mortgage of about $200,000. If rates rise to 5.5%, you can only afford a $176,000 home. At 7%, you can only afford $150,000.

You can see that the effect of rising rates has a bigger impact on higher mortgage balances. This makes sense, considering that bigger loan balances require more interest at higher rates. The most dramatic effect above comes with the $5,000 payment example (in green). At 4.5%, this borrower could afford a home that costs about a million dollars. But if rates rise to 8.5% -- where they were in May 2000 -- then the same person can only afford a $650,000 home. That's nearly $350,000 in lost purchasing power.

If interest rates begin to jump soon, as the housing market remains week, this will make a recovery more difficult for the sector. As rates rise, you might see home prices at the high end begin to decline faster, to better accommodate affordability at higher interest rates. But rising rates doesn't generally result in broadly falling home prices.

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