Buyer purchasing power is a homebuyer’s ability to purchase property funded by mortgage money. The amount of mortgage funds a homebuyer can borrow is based on:
- the homebuyer’s income, which usually adjusts annually at the rate of inflation; and
- current mortgage rates, which change constantly.
As mortgage rates rise, the interest portion of monthly payments on new mortgages increases. The result is a reduction in the portion of each payment which goes toward amortizing the mortgage principal. Thus, the maximum price a homebuyer can pay (their purchasing power) declines with rising mortgage rates.
The opposite is true of falling mortgage rates. When mortgage rates decline, buyer purchasing power increases. The past 30 years was a period of declining mortgage rates, which brought about increased borrowing capacity without the need for an increase in pay. [See Card 5]
Further, little adjustments in mortgage rates significantly affect buyer purchasing power. Consider an average homebuyer whose gross annual income is $60,190. This allows them to make monthly payments (at 31% of their gross income) of $1,555.
The $1,555 monthly payment qualifies them for the following mortgage amounts on a 30-year fixed-rate mortgage (FRM) at different rates:
| Mortgage rate | Mortgage amount |
| 4% | $325,800 |
| 4.5% | $306,900 |
| 5% | $289,700 |
| 5.5% | $273,800 |
| 6% | $259,400 |
| 6.5% | $246,000 |
If the mortgage rate fluctuates by so much as half a percentage point, the mortgage amount changes by tens of thousands of dollars. As a result, when mortgage rates rise, a homebuyer’s income qualifies them for less principal, causing them to become disenchanted and exit the market. Their only other option is to settle for less house than they were able to qualify for at the old mortgage rate, as sellers are slow to drop their price expectations when mortgage rates rise.
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