Two shifts in the housing market inspire prospective homebuyers when making buying decisions. The first is low mortgage rates, while the second is a reduction in housing prices. Deciding which factor is more crucial can make a difference in many aspects, especially in your bank.
However, when it comes to acquiring a house, you’ll realize that asides from the asking price, various other factors make a particular home affordable, such as the interest rate, taxes, house maintenance costs, etc.
While a house might fall within your price range initially, these other factors could make it exceed your affordability range in the long run. This is particularly true when it comes to your mortgage interest rate.
The general logic is that home prices and mortgage rates have a reverse relationship: if one rises, the other falls. Most people believe you can’t have home prices and mortgage rates for a home. Now the big question is, is this true? Also, how exactly do home prices and mortgage interest rates interact, and is one more significant than the other?
This article extensively explores the answers to all these questions and more, comprehensively reviewing everything you, as a homebuyer, should know about home prices and mortgage rates when purchasing a property.
Now, let’s get right into it!
First, What Is Mortgage Interest Rate?
A mortgage interest rate is a sum charged on top of the principal loan by a creditor to a borrower for asset use. It can be determined by the lender and differ among borrowers depending on their credit profile.
The mortgage interest rate can be fixed throughout the mortgage term, or variable, changing with a benchmark interest rate. More importantly, the Mortgage rate average can drastically affect the homebuyer’s market as it can rise and fall with interest rate cycles.
How Home Buyers Are Impacted by Interest Rates and House Prices
The cost of your home and the loan interest rate you used to purchase it both play a substantial role in how much you’ll spend on your house throughout your staying there – or at least until you’ve finished paying off your mortgage.
These two factors influence homebuyers, especially first-time home buyers. Specifically, when the interest rates or housing prices rise, first-time buyers may be unsure or afraid to go into the market. That’s why it’s vital to do your research and ensure the time is right for you to purchase before taking action in the market.
Here are the two (2) major ways interest rates and house prices impact you as a home buyer:
1. Down Payment
Most house buyers who use a mortgage loan to finance their purchase will have to put down a particular percentage of the sale price to avoid private mortgage insurance – this is known as a Down payment.
The golden rule is to pay a 20% down payment when you’re procuring a home, meaning if you’re purchasing a house of $300,000, you’ll pay $60,000 as a Down Payment. As house prices increase, your required Down Payment will also do the same.
When considering the home you can afford, it’s essential to consider how much money you can afford to put down. Many people, of course, can’t afford to pay a 20% down payment. Therefore, various lenders will take as low as 3% down payments; however, a lesser down payment will come with a higher interest rate.
2. Monthly Payment
The home price, Down Payment, and the rate on your mortgage will impact your monthly mortgage payments. For example, if you purchase a more expensive home, your monthly payment will be more. And a higher interest rate will increase your monthly payment also.
Apart from insurance and taxes, your monthly mortgage payment comprises two essential elements: principal and interest. The principal is the original amount you lent, while interest is the amount you’re levied for borrowing that money.
Though it might seem understandable how the home price will influence your monthly payment, you may not know how much your mortgage interest rate can also affect this.
For instance, if you get a 30-year mortgage fixed rate of $200,000 with a 4% interest rate, your monthly payment will be around $955. Compare this with a $200,000 loan at a 3.5% interest rate, with which you’ll have a $898 monthly payment. That’s a $57 difference monthly.
That means, over 30 years, you’ll have paid your creditor an extra $143,739 interest on the 4% loan and just $123,312 on the 3.5% loan.
Low Home Price or Low-Interest Rate; Which Is More Essential?
Scenario 1: Lower Interest Rate
Let’s examine a situation where a buyer chooses a lower interest rate and higher house price. Due to the lower interest rates, the buyer can afford a bigger house, which they deduce its value will escalate.
They buy a $400,000 house and make a 10% down payment. The loan term is 30 years, and their interest rate is 3.25%. Without considering homeowners’ taxes and insurance, their monthly cost will be $1,566.74.
Scenario 2: Lower Home Price
In another case, the buyer opts for a lower house price and instead buys a $300,000 home. Again, they can build equity faster by purchasing a lower-priced house, allowing them to refinance effortlessly. And when you calculate the numbers, their monthly payments are substantially lower.
Keeping all other factors equal, their monthly mortgage payment will be $1,175.06. That’s a difference of $391.68 monthly.
So, which is more significant – the home price or your interest rate?
Of course, lower prices may only come due to higher interest rates. So while the rate is kept constant for comparison purposes, running the numbers yourself based on what’s going on in your market at the time of purchase will be essential.
Can There Be Low Rates and Low Prices at The Same Time?
Simultaneously, interest rates and home prices can drop– this occurred during the great recession. Low home prices and low rates can indicate a declining economy. For example, home prices may decrease during an economic recession, and the Federal Reserve might choose to reduce interest rates to stimulate economic development.
The truth is, it’s tough – if not impossible – to get low rates and low prices at the same time, regardless of what the economy is doing at large, because home prices depend on your preferred location you plan to live and the condition of the housing market in that location, with whether you’re in a seller’s market or a buyer’s market.
Generally, this situation is possibly not something you should hope for, as you could end up waiting longer than you can ever imagine. It isn’t realistic.
The Bottom Line
Waiting for a perfect market condition like this to happen may not always be realistic.
So, if you are considering home prices and interest rates, it’s essential to remember that one isn’t automatically better than the other. Ultimately, it depends on your goals and preferences as a buyer. For example, are you buying a larger home, or do you aim to keep your monthly payment as low as possible?
If you purchase a house with a high listing price or a high rate, ensure you run the numbers to know the short-term and long-term financial consequences of a lower interest rate versus a lower purchase price. And make your move when the numbers make the most sense.
Have further questions? Do not hesitate to give me a call!