The impact of a 1% change in mortgage interest rate
Quick insights
- A 1% increase in mortgage interest rate would raise the monthly payment and total interest paid over the life of a loan.
- Changes in interest rates affect loan affordability across the market because of how the rate impacts repayment. A lower rate generally means more purchasing power, and vice versa.
- When mortgage rates drop by at least 1%, existing homeowners might consider refinancing to save money on interest.
Your interest rate and the type of mortgage loan can significantly affect financial decisions for homebuyers and existing homeowners alike. Rate changes can impact affordability and refinancing. The rate directly affects homeownership costs—they’ll increase with higher rates, while lower rates make homeownership more affordable.
How a 1% rate change would impact your mortgage
The interest rate on a mortgage loan impacts the following:
- Your monthly payment: Your rate is used to calculate the interest charged on your loan balance. Each month, your mortgage payment consists of some principal and some interest (and maybe a few other costs).
- Total interest paid: The interest portion of each monthly mortgage payment you make essentially adds up to the total interest you’ll pay over the life of the loan. The higher the interest rate, the higher that total is, and vice versa.
How interest is used in your mortgage payment
A mortgage payment (the principal plus interest portion) is typically calculated with this formula:
M = P[ r(1+r)n ] / [ (1+r)n−1 ]
- P represents the loan principal.
- r is the monthly interest rate (annual rate divided by 12 months).
- n is the number of payments (loan term in years multiplied by 12).
Common costs like property taxes, home insurance and private mortgage insurance can increase your monthly mortgage costs. Some of these can be included in the payment due to your lender. However, we won’t include them in the calculations below.
Example calculations
We can apply the formula above to an example mortgage:
- Interest rate: 6%
- Rate structure: Fixed
- Loan term: 30 years
- Loan amount (Price minus down payment): $320,000
Approximate costs
- Monthly payment: $1,919
- Total interest paid: $370,682
- Total of mortgage payments: $690,682
Impact of a 1% increase
- Monthly payment: $2,129
- Total interest paid: $446,428
- Total of mortgage payments: $766,428
Increasing mortgage interest by 1% would directly impact your monthly payment. You’d pay more in interest not only every month, but also over the entire loan term. The total interest paid could increase substantially with a 1% rate increase.
Impact of a 1% decrease
- Monthly payment: $1,718
- Total interest paid: $298,419
- Total of mortgage payments: $618,419
Just as an increase would have a corresponding impact on your mortgage payment and total interest paid, a decrease would lower those values.
How the market could be affected by a 1% change in mortgage interest rates
Higher interest rates mean higher monthly payments, which can limit how much a buyer can afford. For the same monthly budget, the increase in rates reduces the maximum loan amount a borrower can qualify for. For instance, if a borrower can afford $1,500 per month, the loan amount they qualify for at 4% would be less than it would at 3%. This might push potential buyers out of the market or require them to look for less expensive homes.
Additional interest rate considerations for homebuyers and homeowners
Calculating the impact of your interest rate on a cost of a home is straightforward, depending on the loan. However, here are some common situations in which the rate will be a deciding factor:
- Adjustable-rate mortgages (ARMs): ARM loans have an interest rate that basically fluctuates with the market after a fixed-rate period. Details of when and by how much will vary. However, any change, including a 1% rate increase, would impact your mortgage costs.
- Fixed-rate mortgages: The interest rate is set when you close, and it may even be locked before that. Timing either of these aspects in your home purchase is important. The rate will remain fixed, as will your monthly payment, for the life of the loan unless you recast or refinance.
- Refinancing: This can lead to savings on your monthly payments and overall interest costs if rates drop by a certain amount. To take advantage of a lower rate market, refinancing options include switching from an ARM to a fixed-rate mortgage (or the opposite). Meanwhile, tapping into your home equity might be useful depending on your goals.
In conclusion
A 1% increase in mortgage interest can raise your monthly payments. You might also end up paying more in interest over the life of the loan, increasing the total cost of buying a home. A decrease would have the opposite effects: lower monthly payment and fewer interest charges. Calculations can show how even a small change in interest rates have a big impact on finances, both monthly and over the life of your loan.
Our calculators and resources can help you feel informed and make a mortgage decision that’s right for you.
