One of the more recent trends we’ve been seeing in the current market from buyers is placing a large emphasis on finding the best possible ‘deal’ out there. I had a buyer tell me this week that while they found a home that was completely remodeled and 100% move-in ready, they were not prepared to ‘overpay and become another statistic.’ The property was certainly not overpriced; it was simply at the high end (not the highest) on the spectrum of comparable properties in the neighborhood. And rightly so – brand new stainless appliances, new granite countertops, new carpet and tile, fresh paint, landscaping, etc.
It’s interesting to see that a lot of buyers are more willing to now buy properties that need a little work, most of the time these being short sales and foreclosures. The trend becomes more interesting when you take into account that short sales and foreclosures usually take longer to close than a property being sold free and clear. But this is the state of the market; buyers are willing to forgo property today in order to get what they feel is the best possible ‘deal’ on property tomorrow.
But lets look at this picture from the financial perspective. There has been plenty of conjecture and opinion about where mortgage interest rates are going, but the common theme seems to be they are unstable and are eventually going up. Here’s a look at average mortgage rates over the past few years. Data provided by Freddie Mac
While there’s no doubt that rates are still low, the Mortgage Bankers Association predicts mid to high 5%s by the end of this year, and low 6%s in 2012. The National Association of REALTORS predicts the same kind of rise. Leading indicators of mortgage rates are also pointing to a rise in rates; the prime rate is expected to slightly rise, US treasury bond yields are expected to rise, as well as increasing uncertainty in the US governments role in buying and insuring mortgages. So what does this mean for buyers?
Let’s take the example of borrowing $200,000 at 5% versus 6% (ancillary costs like insurance and property taxes won’t be included in these calculations for simplicity). If you amortize the terms, you’ll find that the 6% loan payment is only about $125/month higher than the 5%.
However, when you look at the total interest paid over the life of the loan, the 5% will pay $186,511 in total interest while the 6% pays $231,676 in total interest! That’s a $45,165 difference! Even if you decide to sell the property after 10 years, you would have still paid almost $20,000 more in total interest on the 6% than the 5% (since interest payments compose the majority of the total payment in the early periods of the loan).
The higher the loan amount the more staggering the numbers. A $300,000 loan at 6% pays over $67,747 more in total interest than 5%. At $400,000, the difference is $90,329.
Will interest rates rise a full percent in the next month or two? Probably not. But they have risen .77% over the past 5 months. Even 5% vs. 5.77% with a $200,000loan amount, the 5.77% loan has $34,576 more interest built in than the 5%. At $300,00, the difference is $51,864. At $400,000, it’s $69,162.
These are pretty high numbers considering only a 5 month, .77% (that’s three quarters of a percent) change in interest rates.
My advice; don’t get so caught up in finding the property that is priced lowest in the subdivision or has the lowest $/square foot. Don’t let deal-shopping cloud your judgment from finding a home that you love. After all, you’re going to be living there for a while. Look around, but don’t spend an inordinate amount of time doing so. Remember that the final sales price of the home is only one piece of a larger puzzle. If you are a buyer in this market, find a home you love and you can afford. The terms of the loan are most likely going to have a much larger effect on the investment than the final sale price of the home.