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It’s a numbers game.
Let’s say you want to buy a home in today’s market. You have a “life-need” to move-up. You have the income, credit record and work history to buy a home. Although your current home is not quite at its peak, you still have equity.
But you hesitate on pulling the trigger, fearing that the $400,000 home you have your eye on may still dip a bit in price.
What should you do?
“The most dominant factor if are you are buying today is the impact of rising interest rates,” not a major, sustained drop in housing prices, said Lane Hornung, co-founder and CEO of 8z Real Estate and COhomefinder.com.
A rule of thumb is that a home has to drop by 10 percent to make up a 1-percentage point increase in interest rates. In other words, if you want that $400,000 home at the same monthly payment at 6.25 percent as at 5.25 percent, the seller must shave $40,000 off the price and sell it for $360,000.
The numbers bear that out. If you made a 20 percent down payment – $80,000 on a $400,000 home – the monthly principal and interest payment on the $320,000 loan is $1,767 with a 5.25-percent, 30-year mortgage. Jack-up the rate to 6.25 percent and the payment jumps to $1,970 on the $320,000 mortgage.
In order to get the same monthly payment with a 6.25 percent mortgage, the seller needs to drop the price of a home by 10 percent to $360,000. Again, if the buyer puts down 20 percent – $72,000 on the smaller loan- the monthly P&I payment would be $1,773 at a 6.25 percent, 30-year mortgage. So a rate increase of one percentage point is basically a wash if home prices drop a corresponding 10 percent.
But what a qualified, prospective buyer needs to consider is how likely it is that home prices will drop another10 percent to offset a one basis point (one percentage point) increase, if it should occur.
“If somebody asked me to bet $1,000 on the odds of interest rates going up one point or homes decreasing in value by 10 percentage in the next year, I would take the bet on rates rising,” Hornung said.
While there is a strong correlation between rates and prices – rising interest rates will cause sales to go down, Hornung said, but that can be offset by other factors.
Tripod of housing health
“It is my belief that the three legs of the tripod of the home-buying process are interest rates, income (the unemployment picture), and supply of listings,” Hornung said. “If interest rates go up, that is going to cause sales to go down. However, if one of the reasons that interest rates are rising is because the employment picture is getting better, that will help to offset the impact of higher rates.”
Hornung noted that the latest Case-Shiller/Fiserv projection is that many parts of the metro area, including Larimer and Boulder counties, will return to their peak prices in less than two years.
Price drop threat a blip
“If prices do fall a bit, and even if we double dip, it will be a mere blip,” Hornung said, at least in much of the Denver metro area. “That is not true in places such as Las Vegas, Florida, and California.”
Also, according to the latest research from National Association of Realtors, the typical buyer plans to own their home for the next 10 years, almost 43 percent higher than the seven years that historically was the amount of time a homeowner stayed in a home before selling.
“If you’re buying a home as a life-enhancement and not as an investment, and you overlay that on a 10-year ownership horizon, and if we are not at the bottom, we are pretty close to the bottom, it says to me that your real risk is rising rates. My advice is that you just have to be aware that there is a risk of waiting.”
And even if rates rise to say 6 percent, or slightly above, that is not the end of the word. Indeed, not that long ago people were happy to refinance into rates at 6 percent or higher.
Rising rates not all bad
“Personally, I think we can have a very healthy market if interest rates do not go sky high,” Hornung said. “We’re talking about coming off our historic lows of rates in the 4s, and in some cases in the high 3s. If interest rates go to 6 percent or even the high 6s, it’s not like we’re returning to the late ‘70s when rates were at 18 percent.”
He said if he had to choose between super-low interest rates and a bad economy, and relatively low interest rates and a better economy, he would always choose the latter scenario.
“We can have a very healthy real estate market with 6 percent interest rates,” Hornung said.
8z Real Estate is a sponsor of InsideRealEstateNews. A monthly conversation on a real estate topic with Lane Hornung is a feature of InsideRealEstateNews.