It seems the major news networks can’t let a week go by without bringing up how low the interest rates are. “Interest rates are at 40 year lows!” “Interest rates for buying a home are lower than for buying a car!” Whether it’s a newscaster or a local real estate agent, they go on and on with these comparisons, and they’ve been saying it for months. We have been hearing these figures for so long that we’re de-sensitized to it. So at some point, you have to ask yourself, why is this such big news? Why are they still so excited about it? I’d be glad to help break it down for you.
We’ll start by setting the scene. In this scenario, Mr. Smith is a first time home buyer. Based on a 2005 American Housing Survey (AHS), first time home buyers median purchase price was $150,000. So we’ll put Mr. Smith as the middle of the pack for a first time home buyer, looking at homes at that price. Interest rates have been below 4% for a while (and for an accurate quote of today's rate call our friends at Primary Residential Morgage), but to keep our math simple let’s say that he has been pre-approved by his lender for a $150,000 loan at 4%.
Now here’s something the average home buyer doesn’t know. Banks are financing what they feel a borrower can afford each month as a payment toward principal and interest (and depending on your loan type, mortgage insurance). If Mr. Smith was pre-approved at $150,000 with a 4% interest rate, then the bank feels he can afford the monthly principal and interest payment of $716. Well that’s great! For not much more than he’d been paying in rent, Mr. Smith can buy his first home!
But, being the patient man that he is, Mr. Smith wants to bide his time and wait for the perfect house to come along. After all, he rents month-to-month and doesn’t mind waiting for the deal of a lifetime.
Now let’s hit the pause button and talk about why the excitement level has been so high about these interest rates. Like I said above, banks don’t finance based on a loan amount, they finance based on what you can afford in a payment, then reverse-engineer what that payment equates to as an overall loan amount over the lifespan of the loan (typically 30 years).
So what does that mean for Mr. Smith if interest rates go up just a half a percent? If the interest rate jumped to 4.5% and we carried over the fact that the bank is concerned with payment, not purchase price, then he’s now only able to be financed for $140,000 home. But what if he could be financed much higher than $150,000 and just liked the type of house he could buy at that price? If the interest rates jumped up to 4.5% he wouldn’t be paying $716 anymore; the new payment would be $760.
Ten years ago, the interest rates were above 7%. At those rates, a $150,000 home would've been a payment of $997 a month! Even just five years ago with rates above 6% the payments would've been $900. Individuals and families who are buying today are literally able to afford $30,000 more house than they could have five years ago. To see how much your principal and interest payment will be affected by increases in interest rates, check out the table below.
Even the slightest increase in interest rates can mean that a buyer won’t be able to afford the home they want and miss out on a terrific opportunity. It’s a rare occasion when homes are available both at lower prices, and the money needing to be borrowed can be obtained at so low an interest rate. We’d love to help you capitalize on the present opportunity to find your new home and even sell your current home to move up into your dream home.
We’re here to help. So let us know what we can do for you!