Every once in a while you will hear that the Federal Reserve and its power to influence the money supply will raise interest rates. I intend to talk briefly about how this directly affects the consumer who intends to obtain a home loan after the rate increase. The main objective is to find out how much monthly additional funds are required for the mortgage payment. After doing this analysis, we will decide whether the rate increase is too costly or if it is affordable for the borrower of the funds. This analysis is not applicable for those who wish to make cash only purchases, however those who are debating between the cash purchase and the loan purchase can continue reading to get an idea of the cost of the monthly loan payments.

First let us start with a few assumptions: Let us suppose you want a 30 year fixed loan, 4% interest rate, $500,000 loan amount. With this information, we can now solve for the monthly payments. The monthly payment is $2387.

Scenario 1: What if the interest rate rises to 4.5%? The payment rises to $2533. That is a $146 difference.

Scenario 2: What if the interest rate rises to 5%? The payment rises to $2684. That is a 297 difference from the original amount.

Let’s make an interpretation of these data. Namely, what is an extra $146 a month, or $1752/yr? That amount could be the amount of your monthly coffee bills, or monthly going out for good cost. It could be a fraction of your grocery cost. In the big picture, the increase is not that much.

One objection to this is that it could be substantial if you don’t have that much extra funds, or you have a very demanding lifestyle where you need to eat out a lot.

One reply to this objection is that the cost to obtain this money is inexpensive. When we take out a home loan, we are accelerating our means to purchase a home. In return, you make payments to cover the loan until the loan is due or paid in full. Imagine if you had to wait until you saved $600,000. Wouldn’t that take a while, conventionally speaking? Instead, isn’t it faster to save up $100,000 and get the rest in the form of a loan? That is what the loan accomplishes. The rate increases are inconvenient to the borrower but they may not be as groundbreaking as people believe.

In summary, you might find interest rate increases inconvenient, and they might be more than inconvenient when the rates spike. However if the increases are only in small increments, you might find the cost of the monthly mortgage payment to be slightly more expensive, but tolerable, and not earth shattering as some people tend to believe.