Mortgage Matters: When considering prices and interest rates, how do you choose? (column)
I would describe the current real estate and mortgage financing cycle or environment to be one of both increasing interest rates and rising property values. Such circumstances can make both buying and financing a home a bit tricky. So, if I could give you, as a qualified homebuyer, two options, which would you choose?
Option No. 1 would be buying a home right now at current market prices and current interest rates. Option No. 2 would be taking a 5 percent reduction to the sales price but with a half-point increase in the interest rate. Which would you choose as the more financially advantageous option?
Defining those numbers may help analyze the scenario. In order to define or set “current market conditions,” or the first option, let’s assume a sales price of $400,000, a 20 percent down payment and a loan amount of $320,000, with a standard 30-year, fixed-rate mortgage at 4 percent.
Defining the second option, 5 percent off of the sales price would reduce that figure to $380,000, making the loan amount $304,000 (still assuming a 20 percent down payment). The 30-year, fixed rate would increase to 4.5 percent.
Which would you choose?
Examining the numbers a little closer may help in the decision. With the first option, the monthly payment at 4 percent is $1,527.73, and interest paid over the entire 30 years is $229,980. Interest paid in the first five years alone adds up to $61,100. Assuming a 5 percent reduction in the sales price and a 0.5 percent increase to the rate, the monthly payment at 4.5 percent is $1,540.32. Interest paid over the entire 30 years is $255,600, with $66,600 paid in the first five years.
My point is simply that increased interest rates cost a borrower much more interest than is often realized, as illustrated by the numbers above. Even with a reduction in the sales price and loan amount, a half a percent increase to the rate would increase the interest paid on the loan by roughly $25,620 over the life of the loan and by about $5,500 in the first five years alone.
I don’t know if home prices will fall 5 percent. Given that we typically see more properties come on the market in spring, summer and fall, there could potentially be more opportunity for borrowers to negotiate on price. I am not a real estate agent, and a professional agent should certainly be contacted for this part of the conversation.
However, I do firmly believe that interest rates will continue to increase. While interest rates are still at historically low levels right now, all financial markets are dubious, volatile, erratic and subject to swift and vicious changes.
Countless factors go into determining long-term mortgage interest rates. To illustrate a few points indicating increasing mortgage rates, here are a few specific examples: Inflationary numbers are starting to rise on the wholesale and consumer levels, albeit slightly for now. Stock markets and equities are increasing at a rapid pace currently. Government stimulus that for so long kept rates low has ceased.
I could go on and on with reasons as to why rates are volatile and erratic, but they are still historically low for the time being. Nonetheless, the simple mathematics of increased rates is not debatable. Furthermore, a borrower’s buying power is decreased with rate increases, which could make even a 5 percent reduction in sales prices a mute point. Current interest rates and home prices are truly a once in a lifetime opportunity.
William A. DesPortes works for Central Rockies Mortgage Corp. He can be reached at 970-845-7000, ext. 103, and email@example.com.