Recent interest rate hikes have made budgeting for a home more challenging than in previous years. Rising home prices, increasing mortgage rates, and overall economic inflation have affected affordability, making it harder for buyers—especially first-time homeowners—to determine if a mortgage fits within their budget. However, with the right strategies, you can still navigate the housing market successfully.
Here are key steps to budget for a home while managing rising interest rates.
1. Gather a Solid Down Payment
One of the best ways to reduce your mortgage costs is by putting down a larger down payment. A higher upfront investment lowers your loan balance and may qualify you for a lower interest rate.
- Target 20% Down: A 20% down payment eliminates private mortgage insurance (PMI), which can save you hundreds of dollars per month.
- Explore PMI-Free Options: If 20% isn’t possible, look for mortgage programs that don’t require PMI, such as VA loans for military members and veterans.
2. Know Your FICO Credit Score
Your credit score plays a significant role in determining the interest rate you qualify for. The best mortgage rates are reserved for borrowers with excellent credit (740+ FICO score).
How to Check and Improve Your Score:
- Check your FICO score through banks, credit unions, or Experian (for free).
- Avoid relying on VantageScores (like those from Credit Karma), as most lenders use FICO scores.
- Pay off existing debts and avoid new credit inquiries before applying for a mortgage.
3. Use Mortgage Calculators to Budget Realistically
A mortgage calculator can help estimate your monthly payments based on different home prices, loan terms, and interest rates.
- Factor in homeowner’s insurance and property taxes, which significantly affect monthly costs.
- Test different interest rate scenarios to see how your payments might change if rates increase.
- Recalculate your budget whenever the Federal Reserve adjusts interest rates to stay ahead of market changes.
4. Don’t Default to Your Pre-Approval Amount
Lenders often approve borrowers for more than they can comfortably afford. Your pre-approval amount is based on financial formulas, but it may not include:
- Property taxes
- Homeowner’s insurance
- PMI (if applicable)
- Maintenance and unexpected expenses
Instead of maxing out your pre-approval, determine a comfortable monthly payment and use that to set your home price limit.
5. Consider an Adjustable-Rate Mortgage (ARM)
If you plan to move within 5-7 years, an adjustable-rate mortgage (ARM) can offer a lower initial interest rate than a traditional fixed-rate mortgage.
- Typical ARM Terms: 5, 7, or 10 years at a fixed rate before adjusting.
- Key Risk: If rates rise after the fixed period, your mortgage payment may increase significantly.
- Refinancing Before Adjustment: Be prepared to refinance before the rate adjustment if necessary.
6. Wait for Interest Rates to Decline (If Feasible)
Interest rates are rising due to inflation, but they won’t stay high forever. If you don’t urgently need to buy, waiting could benefit you in two ways:
- Lower mortgage rates in the future could improve affordability.
- Housing prices may stabilize, making homeownership more attainable.
During this waiting period, focus on:
- Increasing your down payment savings
- Improving your credit score
- Reducing debt to improve your debt-to-income (DTI) ratio
Final Thoughts
Budgeting for a home with rising interest rates requires strategic planning, careful financial assessment, and flexibility. By saving for a larger down payment, improving your credit score, using mortgage calculators, and considering adjustable-rate loans, you can navigate the market more effectively. If affordability remains a challenge, waiting for rates to stabilize may be the smartest financial decision. Always work with a trusted mortgage lender to explore the best financing options available for your situation.
