This is going to be a short one, I assure you. This is probably stuff you already know, but I think now’s a good time to bring it back up and have a bit of a refresher course. Are you ready?
When people talk about The Fed and “rates”, they’re not talking about home mortgage interest rates . . . at all. They’re talking about the “Overnight Lending Rate” – this is the rate at which banks borrow money from each other – and it’s a short-term rate. Mortgage rates, by their very nature, are long-term rates. Are you still with me?
The Fed cuts rates to fuel economic growth and/or allow inflation to rise. While that’s great for our 401Ks and the like, those things are bad for long-term rates like the ones we seek for home loans. Conversely, when we have trade tensions and other global concerns, people get nervous so economic growth stalls and inflation stagnates.
In coming days, if The Fed chooses to HELP the stock market by cutting rates, we’ll have to wait and see what the market’s reaction does to the long-term rates. Put simply: anything that helps stocks is usually not a help for long-term mortgage rates.
Have I oversimplified it? Of course I have! However, when you hear two guys at the barbershop (if such a place even still exists) having a chinwag about what the talking head on TV just said about The Fed raising or cutting rates, you’ll be smarter than 95% of the population and know where mortgage rates are headed. Don’t let that go to your head, though – it might make it difficult for the barber to give you a proper cut.
Each week, I’ve tried to take both simple and complex mortgage-related topics/issues and put them into terms here in this newsletter that make them more easily understood. Since I’ve been doing that for quite a while, I have to be honest and admit this: I’ve come up dry this week on what to talk about, so I thought I’d do a little internet research (I believe the technical term is Googling) into what mortgages are like in other parts of the world –and after a relatively brief Googling, I’ve found that we here in the United States, well, have it pretty good. True story!
In a lot of other developed countries, mortgage interest isn’t tax deductible at all or there’s only a very limited tax benefit to be enjoyed from it –in Germany, they give tax incentives to encourage people to continue RENTING! In many of those same countries, a 30-year fixed mortgage is only a thing of myths. What? How do they afford a mortgage in other countries? Here’s a breakdown of what is most common in some of these countries:
Canada, Britain, Australia, New Zealand: no fixed-rate loans, only Adjustable Rate Mortgages and Hybrid ARMs with fixed rates for only 10 years.
Germany: fixed-rate loans up to only 15 years, ARMs and interest-only loans.
Japan: fixed-rate loans up to only 20 years, ARMs.
Switzerland: generally, it’s a first and second mortgage; the first has an indefinite repayment period while the second has a fixed repayment period up to 15 years (or until an individual’s retirement age) at a higher interest rate.
I learned two other interesting tidbits:
Prepayment Penalty: in the US, you can get a loan with NO prepayment penalty; in other countries, the banks/lenders have a guarantee that they get their interest even if you pay off your mortgage early.
Non-Recourse Loans: these are available in the US, which means you can lose the property if you default on payment, but the lender cannot seek further compensation from the borrower even if the property’s value doesn’t cover the full value of the defaulted amount; in other counties, they can come after you and your assets and metaphorically bleed you dry to get back the full value.
As difficult as it is to save for a down payment –whether it’s 5% or 20% –the sacrifice is worth it because home ownership isn’t just possible, it’s encouraged here in the United States. If this doesn’t convince you that it’s better to buy than rent, maybe it’s time to learn German and move.
Full disclosure: this is a reprint from a few years back – I’ve updated the numbers to reflect the conditions occurring in the market today.
The New York Federal Reserve’s economists conducted a study and published the results: changes in down payment requirements have MORE influence over home buyers’ willingness to buy than changes in rates. Surveying both buyers and renters, the Fed found that the effect of interest rates may be overrated when compared to even small changes in down payment requirements. The study found:
• Dropping the down payment from 20% to 5% increases the willingness to purchase, on average, by 15% among buyers and 40% among renters
• Decreasing the interest rate on a 30-year fixed-rate loan only raised the willingness to purchase by 5%, on average
As you straddle the fence between BUY RIGHT NOW with a higher interest rate and WAIT AN UNKNOWN PERIOD OF TIME to save 20% of the purchase price, here’s an example to give you a push. Take a look at the numbers for a house with the purchase price of $250,000 with a 30-year fixed mortgage: (1) WAIT: $50,000 down payment, $200,000 total loan amount, 4.5% interest rate, monthly mortgage (P&I) payment – $1013.37; OR, (2) BUY NOW: $12,500 down payment, $237,500 total loan amount, 4.875% interest rate, monthly mortgage (P&A) payment – $1256.86.
No doubt $1013.37 is better than $1256.86 for a monthly payment – that’s not what’s at stake here. The difference between those two payments is $243.49. In order for a person to save the additional $37,500 to go from a 5% down payment to a 20% down payment at the rate of $243.49/month, it would take 154 months – 12 years and 10 months! – to get to that point, which is almost half the life of a 30-year mortgage. Obviously, for many perspective buyers, that additional $244issignificant. Wehave a number of strategies to help make up that difference so you can get into a home as soon as possible!
When this was originally written, interest rates were fairly steady –even stagnant –so the scenario of waiting to amass a larger down payment to get a better interest rate was much more plausible. As we’ve seen recently, though, rates are not going to be stagnant –this is not a pronouncement that they’re going to skyrocket overnight –so this has taken on a greater sense of immediacy to get into a home rather than sitting on the rental sidelines for who knows how long.
For those of us who are complete nerds and sat on the edge of our seats to see if The Fed would decide to raise the overnight lending rate again in their most recent meeting, we were both let down and excited –no change, of course. For those of us who aren’t quite so nerdy but do, in fact, care about what interest rates are doing and will be doing, I wanted to take this moment and interject a little . . . calm. Let’s take a look at a handful of things, okay?
While interest rates today are creeping in the upper 4s to lower 5s, please remember that back in 1981 (yes, I realize many of you were not even born, but I’m not asking for a show of hands) interest rates peaked just over 18.5%. Yes, you read that correctly –about FOUR TIMES the rate we’re dancing with at the mortgage disco today.
The average price of a new home back in 1981 was $83,000. On a fixed-rate, 30-year mortgage for such a house, the principal and interest payment at 18.5% would be approximately $1,285/month. (I went straight off $83K as my loan amount –I didn’t account for a down payment.) Using a handy-dandy app on my phone, I see that $1,285 in 1981 would be equal to approximately $3,485 today. Using a 30-year fixed mortgage at an interest rate of 5%, anyone want to take a guess at the loan amount that $3,485 (principal and interest) in today’s dollars would get you? Anyone? Bueller? The correct answer is approximately $650,000. Yes, you read that correctly, too. Let’s look at all this from another direction.
Using that same nifty app on my phone, I see that $83,000 in 1981 is equal to approximately $225,000 in today’s money. That amount –$225,000 –isn’t going to buy you a mansion (or a moderately sized cardboard box on the beach), but it will certainly start you off in the right direction in building equity, not paying rent to pay someone else’s mortgage, and give you a nice tax deduction. On a 30-year fixed mortgage at 5%, anyone want to guess what the principal and interest would be on a $225,000 loan? For anyone who said $1,208, you’re correct –big gold star on your forehead!
There are two takeaways from this little exercise:
- Rates ARE going to go up. How high? No one knows, but there’s A LOT of room between 5% and the 18.5% seen back in 1981. You can afford a lot more house these days –revel in that and relax!
- Because rates are primed to rise rather than fall, when you get the chance to lock the rate on a current mortgage, you’re usually better off to do it at that time than to “wait and see if it’ll come back down.” Like body weight, it goes up much easier than it comes down.
And remember, 1981 wasn’t ALL bad –it was the year that first gave us MTV, a cable channel that played actual music videos –we needed something to distract us from rising interest rates!