Rising rates and timing your purchases
By Greg McBride, CFA • Bankrate.com

Now that interest rates are on the rise, consumers are confronted with various decisions when it comes to managing debt. Similar decisions also surface about debt that hasn't yet been incurred. Should rising interest rates alter your timetable for buying a new car or buying a home?

Faced with the continuing prospect of rising interest rates, consumers often ask if they should go ahead and buy a new car now in order to lock in the best rates before they rise.

However, the impact of rising rates on the financing cost will prove to be modest and should take a back seat, if you will, to other more critical criteria.

Do the math
Consider a $25,000 auto loan financed over five years. Waiting until rates rise by one-quarter percentage point increases the monthly payment by a scant $3 per month. Waiting until rates go up by one full percentage point -- perhaps six months or more away -- increases the monthly payment by approximately $12 per month.

Potential car buyers will be relieved by that. This means that from a financing standpoint alone, it is entirely possible to accumulate money for a down payment at a faster rate than the financing cost will rise. Other factors being equal -- such as the price of the car -- having a larger down payment means the buyer finances less of the purchase. If the buyer finances $25,000 for five years at 6 percent, the monthly payment is the same as if the buyer waited six months and financed a smaller loan balance of $24,400 at 7 percent.

In addition, the buyer has more equity in the vehicle by virtue of the larger down payment. Beyond the financing aspect, most car buyers would give equal -- and often greater -- weight to things like availability of the newest model year, or whether a new vehicle is truly needed at this point.

The decision faced by first-time home buyers is considerably tougher.

To start with, monthly payments have the potential, as demonstrated in recent months, to increase at a faster rate than people can save money. Since fixed mortgage rates are tied to yields on long-term government bonds, they can increase much faster than what is likely to be seen with short-term interest rates. Consider the sharp move in mortgage rates between mid-March and mid-May, where the average 30-year fixed mortgage rate jumped from 5.4 percent to nearly 6.4 percent. In this case, waiting meant the monthly payment on a $200,000 loan would have cost an additional $128 per month. This alone adds a sense of urgency to buyers.

The mortgage dilemma -- worse in hot markets
But the continued escalation of home prices also impacts affordability. Reports of limited supply, bidding wars between prospective buyers, and red-hot real estate markets where prices seem to be on a limitless trajectory are enough to make home buyers reach for the antacid. Waiting seems to offer no assurance that prices will become any more affordable as time goes on. Buyers often have the feeling of being squeezed out of the market by waiting -- by rising prices, interest rates, or both.

No magic answers seem to exist for home buyers, where the cost of locking in a mortgage rate for six months could cost two points, or 2 percent of the amount borrowed. What's more, this rate isn't locked as much as it is capped at some point -- say one-half percentage point -- above the present level. A significant cash outlay to protect against rising rates in the next six months only guarantees a ceiling on the mortgage rate, not the mortgage rate itself.

With the spike in fixed mortgage rates, consumers continue to beat a path toward potentially riskier adjustable-rate mortgages. While hybrid ARMs can be a great mortgage choice, chasing lower rates could find the borrower with an interest-only mortgage, a loan that becomes adjustable sooner rather than later, or worst of all, a negative amortization loan that actually adds to the loan balance over time. Buyers clutching to home affordability now may not feel that waiting is a suitable option, but taking on a burdensome monthly payment or the risk of being priced out of your own home in the future is no better. After all, it is your budget, your credit, and your home at risk.

Greg McBride is a financial analyst for Bankrate.com.

For advice regarding your specific situation, please e-mail one of Bankrate.com's Q&A experts or visit the Personal Finance Advice & channel on Bankrate.com.