Two housing-market shifts encourage potential homebuyers to call real estate agents: drops in housing prices and low mortgage rates. Deciding which factor is more important can make a difference in monthly payments, the ability to move if your home value drops and homeowners association (HOA) fees.
Suppose you started the home search process when interest rates were 6%. You saw a one-bedroom condo for sale for $100,000. You calculated your 30-year monthly mortgage payment on $80,000 – the amount you would be mortgaging after a 20% down payment and your closing costs. Your monthly payment would be $480.
You decide you don’t like this payment and rate, so you wait six months and the interest rate drops to 4%. However, a condo in the neighborhood you want now costs $120,000. You put down 20% plus closing costs, and you are left with a mortgage of $96,000. Your monthly payment on a 30-year mortgage is $458. Your payment dropped by $22.
But does a payment drop financially make up for the higher down payment? Factoring in that your down payment was $4,000 more, you still save about $10 to $11 per month – around $3,920 over the course of 30 years.
If real estate prices had not risen in your prospective neighborhood from the $100,000 price point with which you started and you had snagged a 4% interest rate, your monthly mortgage payment would have been $382. You can use Investopedia's mortgage calculator to see what your payments would be.
In the example of the condo that rose from $100,000 to $120,000, your monthly payment dropped because of a lower interest rate. But would the lower payment help you if you didn’t have an extra $4,000 for a larger down payment? The difference in the down payment could eliminate the possibility of buying the home you want or knocking you out of the buyer’s market altogether if you can’t find a cheaper neighborhood. Also, losing that extra $4,000 will affect your ability to pay for unexpected home repairs, lower the amount of your emergency savings and diminish your ability to afford to furnish your new home.
Can Low Rates and Low Prices Coexist?
How do you know what a low rate is? You can find historic mortgage rates and housing prices on the Freddie Mac website. For example, in 2012 interest rates and housing prices were both rather low when compared to the previous and following three to five years. Look at the last five years for highs and lows compared to the current situation.
There’s no assurance that history will repeat itself and create another low prices/low rates housing market. According to property market analysts in a February 2018 Reuters poll, U.S. house prices will rise at double the pace of inflation and wages this year. The supply of single-family homes is falling short of rising demand, making housing less affordable. If you need a house soon, the option to wait for an ideal housing market circumstances may not be realistic.
Interest rates don’t matter as much if you can easily afford your payments and live in your home for five years or less. While it’s never a guarantee that housing prices won’t drop further, you can view estimated housing prices for the last 10 years by selecting an address in the neighborhood you are studying online.
Always compare neighborhood values instead of national or city by city. Home price patterns vary greatly from neighborhood to neighborhood and state to state. The likelihood that you will owe more than your home is worth (known as being underwater) will be less if you buy a home when your local real estate market is below its peak.
Not every house you consider will be in a planned or gated community or condominium with an HOA. But if that’s where you end up, realize that HOA fees are often more expensive for higher-priced homes and can climb higher when more homes are vacant. Why?
HOAs cover shared services such as lawn maintenance, condo maintenance, clubhouses, pools, tennis courts and/or private streets. When fewer homeowners share the cost, HOA fees go up. As with other historic data, you should contact potential HOAs and ask for rates over the last 10 years.
You should also ask about maximum fees and which factors determine rate hikes and decreases. Always ask about HOA fees on all homes you are considering. HOA fees may be lower on a slightly higher priced home, especially if fewer services are offered. In low-interest-rate environments, HOA payments can present an excessive monthly burden, so make sure that these payments are factored into your monthly budget.
An advantage to buying at a lower home price compared to having a lower interest rate is that your home can be refinanced or modified in the future. If interest rates decrease, you can lower your costs. Basically, the problem with high initial interest rates can be mitigated in the future if rates decrease.
If your current home’s interest rate is significantly higher than current rates, ask potential mortgage bankers how much it would cost to modify your loan. The range can be anywhere from free to thousands. There’s no guarantee that home loan interest rates will drop, but you can make sure that you can afford to refinance if they do.
The Bottom Line
The decision to buy a home should always be based mostly on your ability to afford the monthly payment, down payment, home repairs and furnishings, while having enough left for an emergency fund. Always consider factors such as HOA fees and the option to pay down your mortgage if you must move quickly.
Ideally, buy when both interest rates and home prices are low. If that’s not possible, calculate both short- and long-term costs of a lower interest rate versus a lower purchase price. When the numbers make the most sense, make your move.
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