With the real estate market under a microscope these days, there’s lots of talk about “waiting for the market to bottom out.” Of course, the clearest signal of home prices hitting bottom is looking back after they’ve gone up and saying “Oh, look, that was the bottom back there.” So let’s put price aside for a moment and talk about interest rates.
Most home purchases are financed, often over 30 years. Monthly payments are generally a combination of Principle (the amount borrowed), Interest, Taxes, and Insurance; or PITI. The bulk of the PITI payment is usually the principle and interest (PI), of which a whole bunch is interest. In fact, more than half of the PI goes toward interest for the first 18 1/2 years of a 30 year loan, and that’s based on today’s favorable rates. Really.
Rule of Thumb: When interest rates go up one percent your purchasing power goes down ten percent.
The table above shows the Principle and Interest payment at various purchase prices with a 10% down payment.
As you can see, the payment for a $200,000 house at 6% interest is almost identical to the payment for a $180,000 house at 7% interest. When interest rates go up one percent purchasing power goes down ten percent. Look at it this way: Let’s say you are in the market to buy, but only if the right deal comes along. You’ve established your price range to be about $200,000 based on the monthly payment of $1079.19 at 6% interest. If interest rates went up to 7%, you would be shopping for a $180,000 house instead of a $200,000 house to maintain the same monthly payment.
“So, when you talk about low interest rates…”
The monthly average interest rate for a 30 year fixed rate mortgage fell below 6% for the first time in at least 30 years back in January of 2003. Record or near-record lows continued for much of 2003 – 2005 before climbing back over 6% throughout 2006 and 2007. For some historical perspective, take a look at interest rates over the last 35 years.
Interest Rates on the move in 2008
After floating betweeen between 6.1% and 6.76% for more than two years, the average rate in January of this year was down to 5.76% before steadily moving up to 6.04% in May. That 1/4 point move in 2008 works out to $32.25 per month on a $200,000 house.
I can’t predict what rates will do moving forward. Energy costs, stock market, value of the Dollar, the Fed… There’s a lot at play. I do know that rates are extremely low compared to any other time in history, which tells me price isn’t everything when comes to buying a home.
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