Housing Prices vs. Interest Rate

[svferris]

Hoping somebody here can help answer my newbie question:

My wife and I have about $80,000-$90,000 in savings that we’ve earmarked for putting down on a house. I’ve been saying for a couple years now that things are too expensive and prices will come down. The response I get from a lot of people is that we should get in while interest rates are low and that if we wait, the rates will just go up as prices go down, so we’ll end up paying the same for the house.

This doesn’t really make exact sense to me. Doesn’t it seem smarter that my $80,000 makes up 25% of a $320,000 place vs. 12.5% of a $640,000 place. (Pardon the random housing prices, just trying to make a point).

It also seems to me that financing $240,000 vs. $560,000 just makes more sense, regardless of a higher interest rate. Just how much higher would interest rates have to jump for all things to be equal? And would we really expect that kind of jump in the next 3-5 years?

Please help me clarify this to help put both myself and my wife at ease. Thanks!

[nhamlin]

You are exactly correct for several reasons.

If you have a high interest loan but the same house payment as a lower interest rate loan several good things can happen. you can make extra principal payments which are the equivalent of investing money at the 12% rate. If Rates drop, you could refinance and have a far lower payment. Alternatively you could refi at the lower rate, make the same payments and have large principal paydown.

If you buy while rates are low and prices are high there is not much more good news to be had. If rate rise dramatically the market value of your home will drop. If rates do not fall, you will have a very large loan and will pay on it forever.

I cannot imagine a happy ending to a story that starts out: Once upon a time I bought a house when rates were at a record low and people were paying such high prices that their payments were at record levels relative to income. Then rates went up dramatically.

Remember that an increase in rates from 5% to 7% means a 40% increase in interest payment! It was not that long ago that 7% financing looked like the impossible dream.

Norm Hamlin
[email protected]

[OwnerOfCalifornia]

There have been a few threads on this subject recently but I am too lazy to look them up at the moment. The conclusion from those threads is that it is better to buy at a lower price and higher interest rate, for these reasons (payment being equal):

1) Obviously, it is better to owe the bank $320,000 instead of $640,000.
2) You get a much larger tax write-off with a higher rate.
3) With a high interest rate, you can refinance if rates drop. It is hard to imagine refinancing a loan taken out at today’s rates.

I think there are a couple other reasons I am missing.

[fencewalker]

Don’t forget the lower property tax payment on a less expensive property.

[powayseller]

And the lower property and earthquake insurance.

Another reason: say you want to sell your house before prices ratchet back up to today’s levels, so within the next 15 – 20 years. If you wish to leave San Diego for your big job opportunity, you could find yourself upside down on the mortgage.

Interest rates would have to double to 12% before you reach a payment equivalent to today’s payment. Assume a $950K house at 6% today, vs. a post-bubble $475K house at 12% interest. Both have annual interest of $57,000 in the first year.

Against that, weigh the interest you’re earning on your nice savings (hey, good job on saving that much!). Do you think it’s likely that interest rates get that high, to 12%? They could, so that’s a definite consideration.

Some folks may not want to wait until the last dollars are eked out of this bubble. Perhaps you will wait 2 or 3 years to get in. You will come out ahead by waiting.

By summer, everyone will know the spring rally didn’t happen.

I spoke w/ a realtor today about his listing that shows a Trustee Sale on RealtyTrac.com. His listing is on my friend’s street, and she and I discussed taking our kids on a fieldtrip to the courthouse next week to see the auction. It turns out they just got an offer on the house, and asked the bank to withdraw the Trustee Sale and accept the offer. The realtor told me the foreclosures are just starting. He sees 100-200 every day (week?) on RealtyTrac, and knew years ago, when exotic loans were popular, that this would be the result. He told me there will be a huge wave of foreclosures later this year, as more people lose their homes because of these loans.

My husband is dreaming of buying a house near the beach. By 2010, I am sure our money will buy a house on the beach.

[Author]

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