What homebuyers should understand about current interest rate hikes

This is the interest rate banks use to lend money to each other overnight, according to the Federal Reserve. Banks are legally required to keep a certain percentage of their customers’ money on reserve, prompting banks to aim for keeping enough money on reserve without going under their limit.

Why change the rate?

This is used by the Federal Reserve to both control the supply of money available and keep inflation in check. As the rate goes up, it becomes more expensive to borrow money or take out a loan.

Calculating an interest rate

A bank or mortgage lender will base its best rate—or prime rate—off of the fluctuations in the federal funds rate, according to the Consumer Financial Protection Bureau.

What is the prime rate?

The prime rate is usually determined by adding three points to the federal funds target rate, but that can vary depending on the bank and other factors, according to Bill Chittenden, associate professor of finance at Texas State University.

Current 30-year fixed rates dropped slightly in June from a high of 6.79% to 6.71%, according to Freddie Mac.

Chittenden said for a homebuyer who has a budget of $1,500 for a monthly payment, that buyer could afford a roughly $350,000 mortgage two years ago.

Due to increases in the federal funds rate, that same monthly payment could only get them a $260,000-$270,000 home in the current environment.

What can I afford?

Mortgage interest rates determine the monthly cost of a home. These examples are based on reported average interest rates by Freddie Mac each June from 2020-23 with a conventional 20% down payment and a 30-year fixed mortgage. The following does not take into account property tax rates, homeowner insurance, homeowners association fees or other costs that go into a total monthly payment, per Freddie Mac.

• Home cost: $350,000
  • 20% down payment: $70,000
  • Loan term: 30-year fixed
• Monthly principal and interest payment
  • June 2021: $1,183 (3.02%)
  • June 2022: $1,634 (5.75%)
  • June 2023: $1,808 (6.71%)