Why do higher interest rates make it harder to qualify for a home loan?

On Behalf of | Dec 13, 2022 | Real Estate Transactions |

If you have been paying attention to mortgage rates recently, you know that they are high, with the average rate at 7.32% as of early December. Not only are they high, but analysts also predict that they will not peak until mid-2023.

Unfortunately for aspiring homeowners, high mortgage rates make it far more difficult to qualify for home loans. The Ascent explains why this is and what you can do about it.

Why high mortgage rates make it more difficult to qualify

The reason high mortgage rates make it difficult to qualify for a home loan is that loans with higher rates are more expensive. Lenders have restrictions regarding how high monthly mortgage payments can be relative to a person’s income. When rates go up, monthly payments become bigger.

Before approving a loan, lenders consider two key numbers. The first is your front-end debt-to-income ratio, meaning your housing cost compared to your income. Housing costs include the mortgage principal and interest, home insurance and taxes. These costs cannot exceed 28% of your income.

The next number lenders consider is your back-end ratio, meaning the cost of all your other debts compared to your income. These total debts, including future housing costs, cannot exceed 36% of your income.

How to increase your odds of approval

The most obvious way to increase your odds of approval is to keep your projected housing costs low. This typically means borrowing less by either shopping for a home that does not cost as much or making a bigger down payment. By doing either of these things, you can pay less in both principal and interest. Though your rate will still be high, you can keep your debt-to-income ratio below allowable limits.