Understanding The True Cost Of Mortgage
Mortgage loan rates are the lowest they have been in nearly 60 years, and the purpose of this article is to illustrate why this is a big deal.
First, let’s look at interest rates and housing prices.
Interest rates are just under 3.5% for a 30 year fixed APR, and the average house is selling for almost $700,000. This begs the question: Is it a good time to buy, and more specifically, does the low cost of a loan outweigh the high price of housing?
Housing prices and loan rates will inevitably fluctuate. There are many opinions and influencing factors about the future of real estate’s value. I’m not here to predict the market, but rather give a few key insights as to when is the correct time to purchase a home.
Understanding the total cost of a house when including interest rates can be the difference between prosperous ownership and suffering under the burden of high mortgage payments.
A little-known fact:
The truth is that a fully amortized loan of $500,000 USD at 3.5% APR will cost the homeowner a total of $808,280.44 after 30 years of payments. This is actually a loan repayment amount of 61%. For the same loan of $500,000 at 5%, the owner would pay a total of $966,278.92, for a total of 93% loan repayment. A difference of roughly $158,000 for a seemingly mere 1.5% more in interest, but the reality is about 19% more in total costs.
Getting a good interest rate is crucial, and mortgage loans are extremely cheap right now.
History shows that it is entirely possible for interest rates to climb 3–5% within the next two years. There are numerous examples of this in recent decades. The strange truth is, that even though a house may be cheaper a year or two from now, you could still pay more for it in the long run.
If you are waiting for the right time to buy, an important question should be: How much would prices need to fall to offset the costs of potentially higher interest rates?
To put it another way, which is cheaper: a loan for $500,000.00 at 3.5% interest or a loan for $400,000.00 at 5.3% interest? Surprisingly, they cost almost the same. In terms of ‘true cost’ a $500,000.00 loan at 3.5% is $808,280.44 and $400,000.00 at 5.3% is $799,638.70.
A difference of 1.8% in interests equates to $100,000 in price reduction, or twenty percent, of the overall value.
To simplify this equation it can be represented in chunks of $100,000 and true interest costs.
A loan of:
100,000 at 1% repays $115,790.23, or 15.7% interest.
100,000 at 2% repays $133,063.01, or 33.0% interest
100,000 at 3% repays $151,777.45, or 51.7% interest.
100,000 at 4% repays $171,869.51, or 71.8% interest.
A general guide is that every percent of a loan equates to roughly 16% in total costs, but it should be noted that each percent beyond the first is larger. For example, a 2% loan pays 33% interest which is slightly more than double that of a 1% loan at 15.7% interest.
To summarize, if you are keeping an eye on the market, or just a particular property, know that for every 1% interest rates increase, a house would need to lose around 16% of its value to offset the cost of the loan and be considered a ‘good deal’, at least from a mathematical perspective.
There are things that can be done to mitigate these costs. For example, rates on 15 year loans are over a half point below the thirty year, and refinancing or paying more than the monthly minimum can save the owner a significant amount down the road. More about this in future articles.
Knowing the true cost of a home will empower you to make good decisions both now and in the future.
The above calculations does not include property taxes, maintenance and other associated costs.
If you want to learn more about amortization, keep an eye on loan rates, or do the calculations for yourself. Refer to these links;
Sources:
https://www.investopedia.com/terms/a/amortization, https://www.calculator.net/mortgage-calculator.
https://fred.stlouisfed.org/series/MORTGAGE30US
https://fred.stlouisfed.org/series/MSPUS
For answers to any questions on this topic or anything regarding real estate, please email us — info@partridgerosen.realestate
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