Rates, Not Home Prices, Worst Enemy In Affordability

With all the talk of softening markets, many buyers have moved to the sidelines hoping to wait out high prices, believing that lower prices will help them along the path to homeownership or to move up into the house they really want. Instead of prices, buyers should really keep their eyes on interest rates ? the most powerful component of the home-buying process.

In a nut shell, if you wait for prices to level and drop while interest rates increase -- your ability to purchase that now-affordable home may have just vanished with interest rates running up along side the price drops.

An information sheet came to my desk from a national mortgage company comparing buying power on a household annual income of $100,000 to demonstrate this point and it was quite telling. Now, I know the national median household income is about half that amount, however, the principles are the same of how powerful interest rates affect purchase power.

For instance, in this example, if you?re waiting for prices to drop $50,000 before you buy, hoping to get a better deal ? well, quit waiting. If interest rates increase as the Mortgage Bankers Association of America forecasts, your payment won?t come down with the lower prices. In fact, you may still sit on the sidelines.

MBAA is predicting 6.7 percent rates into next year. Even with that level of increase, historically, that rate is some of the lowest rates you?ll ever see. However, at that amount, the above buyer will only be able to buy about $399,411 worth of house. Last June (just 5 months ago) that same borrower could have borrowed $450,000 at 5.63 percent on a 30-year fixed mortgage. Neither the buyer?s income nor the home price decreased the buyer?s buying power -- just the interest rate.

Here are the nitty gritty details:

The 30-year fixed rate mortgage for $450,000 at 5.63 percent would cost a borrower $2,591.87 per month. For that same borrower waiting for prices to drop, but watching interest rates jump to 6.7 percent, that same $2591.87 will only fund a mortgage of $401,667.91.

If you want to see what that would do in a lower financial stratosphere: let?s say it?s a loan for a $60,000 household budget, instead of $100,000. The purchasing power for this buyer would be roughly $1,550 per month ? that?s a loan for $217,024 at 5.63 percent (including $300 for taxes and insurance). That same money at 6.7 percent will only purchase $193,715 -- a difference of roughly $24,000.

Two words of advice. To those who are thinking about buying -- look at all your options and run your personal numbers. How long can you wait for prices to reduce while interest rates are on the march upward before you?re priced out of your favorite home again. If housing inventory is on the rise in your market area -- then move sooner than later. Smart sellers are willing to negotiate again -- you may be able to get that lower price just by asking for it.

Case in point: Just a couple weeks ago in the D.C. market, a Realtor told me of how he saved his buyers nearly $75,000 from sellers who realized they needed to get going instead of hanging on to their price. In essence, make an offer -- the worst that can happen is the seller will counter your offer or reject it. What is it they say? Nothing ventured ...

Secondly, if you know you?re going to buy -- lock in early and move in on the contract. By locking in you save money by having a lower rate for your mortgage. Some mortgage programs let you lock in for up to 120 days.

Average interest rates have risen by more than half a percentage point in just the last 6 months from 5.62 percent to 6.28 percent, according to Mortgage-x.com?s rate calendar. Depending where rates go, even one month delay in locking in your rate could make a difference of several hundred dollars on your monthly payment.

Published: December 9, 2005