How to adjust your housing budget for higher interest rates

Planning to buy a home takes time because you have to look at your finances, line up a loan and find something you actually want to own.

If you started this process even just a few months ago, you likely did so when interest rates and inflation were both much lower than they are now. Due to ongoing inflation and the recent interest rate hikes, your dollar won’t go as far as it used to — which is a big deal when there are as many dollars on the line as there are when buying a house. (And could get worse if rates increase.)

So, should you abandon your search for a new home? Or should anyone shopping for a house adjust their budget or approach in light of economic changes?

We put that question to Natalie Taylor, CFP professional and head of financial advice at Monarch Money. Here are her answers.

Aim for a cheaper house and a bigger deposit

There’s a saying in real estate that “you live with the payment, not the price,” meaning that, whatever the total cost of your home, the thing that really affects you month-to-month is your mortgage payment. Obviously, as mortgage rates go up, the monthly payment you might have budgeted for previously will now buy you less house than it would have a year ago.

If you’d budgeted to pay out a certain amount each month and you can’t easily increase that number, “You can either adjust the total purchase price downward so that you’re borrowing less, or you can put more down,” says Taylor.

“We always think you put down 20% or the minimum amount possible,” she adds, “and there are some good reasons to put less down. But at the same time, it’s important to get into a mortgage from a cash flow perspective so it fits well into your budget. And one way to do that is to put a little bit more down than you were anticipating so that your mortgage can be smaller and the payment can be more reasonable.”

Shop for low rates

If neither of the above options is appealing or possible, try to find a better loan from your mortgage lender.

“I think shopping for rates is important as well,” Taylor says. “So work with a mortgage broker or just contact multiple lenders to understand what quotes would look like from a credit report standpoint.”

Be aware that you should try to make all of your inquiries within a 30-day window. “To get a real mortgage quote, most lenders are going to want to pull your credit — this is called a ‘hard inquiry,’” says Taylor. Hard inquiries affect your credit score, “but generally any hard inquiries within a 30-day window, to some extent, get lumped together as one inquiry in terms of the amount of impact they have on your credit score.”

That said, “Some lenders will just quote you a loan amount without a credit check if you say you’re sure that your credit score is X and you have excellent credit. That’s the best way to go,” if it’s an option.

You should also look into whether you can negotiate closing costs, which can take up from 2 to 5 percent of your mortgage amount. You can see if the seller is willing to cover your closing costs entirely — a more likely possibility if we shift to a buyer’s market. You might also be offered lower closing costs from an online lender, because digital-first companies can streamline their services and costs, passing the savings onto you.

Think holistically about your move

“Consider how different neighborhoods impact what will happen to the rest of your budget,” says Taylor. For example, if you move to an area with good public schools and easy access to public transportation, you may be able to absorb a higher-than-intended mortgage payment because you now have spare money in other areas of your budget.

On the other hand, if your new home base requires you to buy a car (and then fuel that car) or lengthens your commute, you might look to save on your mortgage payments.

“Evaluate how being in a particular area affects your commute costs and child care costs: how all of those things will change based on the neighborhood that you choose to buy in can either help or hurt from a cash flow standpoint,” Taylor says.

Run the numbers on how higher interest rates affect your budget

“I think one other thing to mention is that, with the change in interest rates, it’s important to do the numbers to see how much it actually changes things for you, because it often sounds scarier than it really is,” Taylor says.

“For example, if you’re borrowing $500,000, then interest rates going from 5% to 6% costs you about $300 more a month.” While that is not a trivial sum (especially over time), you may find rising interest rates more manageable if you adjust other areas of your budget. Also, if you can’t financially absorb a 1% or 2% change in interest rates, that might mean you’re stretched too thin to buy the house you have in mind. (Not to mention, keeping some money set aside for emergencies.)

And then there’s the mental factor. Obviously, you might be kicking yourself if “buy a house” was on your to-do list a year or two ago, and you just didn’t devote the time to looking until now, when your dollar doesn’t go as far. At this point, though, you can’t turn back time — but you might find that the right house is still out there, within budget.