How to think about digesting the math of a home purchase with today’s interest rates.
“The interest rates have gone way up,” my Buyers said. “We’re not sure we can afford Piedmont/Oakland/Berkeley anymore. . . ”
I hear you. The higher cost of money is a tough nut to swallow.
In all seriousness, if you feel your purchasing power has eroded significantly during the past few months, that’s because it has. But for those Buyers choosing to sit it out on the assumption that the market is going to correct further still (it very well may), how’s it going to feel when the Feds increase the rates again – as they are expected to do the next two times they meet — and suddenly, you can afford even less?
In other words, what are you waiting for?!?
Unlike a sale at Nordstrom’s, a discounted price in the housing market doesn’t necessarily work in your favor IF the interest rates continue to climb. In fact, as interest rates rise, the ability to purchase goes down in corresponding measure.
Put in simple terms, if you buy in today’s current marketplace with a $2m loan (interest only) the carrying costs are as follows:
@ 5% = $100,000 annually or $8,333 monthly
@ 6% = $120,000 annually or $10,000 monthly
@ 7% = $140,000 annually or $11,667 monthly
Last spring at 3%, the yearly payment on $2m would have been $60,000 annually or $5,000 monthly. (Thank you Chad Rego of First Republic Bank for the education.) No wonder Buyers are reeling. That’s a BIG difference.
But here’s a cautionary tale for both Buyers and Sellers . . . after the 2008 financial meltdown, housing prices experienced the overdue correction many people had been waiting for (yes, even here in Piedmont), but conservative lending institutions responded by making money so difficult to borrow that many of those Buyers no longer qualified for a loan and were shut out entirely.
While we’re in a different place this time around with respect to lender defaults (today’s Homeowners have far more skin in the game), for Buyers, Sellers, and Lenders this is still about the actual cost to borrow money.
For those of us with a much longer lens and a deeper perspective, (aka older) we came to the housing market when interest rates were in the double digits and a rate drop to 10% seemed like a gift from heaven. Consequently, we are here to tell you that even at 6%, lending rates are still historically low.
That’s little consolation for those who missed the low water mark with respect to interest rates and are now forced to work in a marketplace that’s suddenly offering much less. If your housing needs are imminent, you will have to adjust (as will the Sellers) who are now going to see offers come in at less than ask, AND with contingencies back in play. (If you’re the only offer, there’s no reason to waive your due diligence or lending conditions.)
The tough truth is it was easier to afford a MORE expensive home at a lower interest rate than a less expensive home at a higher interest rate.
Why?
Because it’s never really about the amount you offered to secure a property, but about the monthly costs to carry that home, also known as PITI (principal, interest, taxes, insurance). Put another way, unless you plan on living in your home for 30 years, you aren’t likely to ever pay off your loan in full; you’re far better off carrying that debt until you sell (and writing off the interest). You are, however, much more likely to refinance your debt when the rates change in your favor (as most of us did during the last two years).
Remember, unless you are an ALL-CASH Buyer, when you purchase a home, you are leveraging your hard-earned cash. For most of us, it’s the bank that’s doing the heavy lifting; our real investment represents a much smaller percentage of the purchase price (usually 20%).
Do the math
So weigh out your options, set pencil to paper, and recalculate what you can now afford, WITH the understanding that you’ll afford far less when rates hit 7% (a reasonable expectation).
Finally, timing the marketplace is an impossible task that only ever happens in a rearview mirror. If you need to buy or sell a house NOW, you’ll need to work in today’s current marketplace, nuts and all . . . otherwise, you may be waiting years to get back to where we were last spring.
How can we help you?
Julie Gardner & Sarah Abel | Compass Realty
Not just Realtors, but consultants in all things house and home, we’re here to educate, explore, examine and refer . . . In short, you may count on us to take care of your home as if it were our own and anyone who knows us, knows we take pretty darn good care of our homes.
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