There are few things more terrifying to a soon to be home buyer than rising interest rates. Most potential buyers know the areas they want. They’ve identified the neighborhoods they like, the schools they want, the size and type of house they’re gunning for, and they’re just waiting for the right house to pop up. These are all pieces of the larger, longer term process of buying a house, but at the core of this process is figuring out how much buyers can spend and still afford the house.
Affordability is unfortunately at the center of the national housing crisis. The stock of houses for sale just cannot seem to meet demand, and the cheap money from the last decade drove up demand on the existing supply of houses. Most of those sitting on the sidelines were waiting for the market to cool before jumping in, but one key assumption went along with that waiting: the cost of money would stay the same while the market came back to reality. This was a rough assumption for people to make.
The market has started to soften, yes, but it is doing so because at least in large part because the cost of money has gone crazy. Eight months ago you could purchase a home with a conventional 30 year fixed rate loan and expect to pay no more than 3% interest. Now that exact same deal will likely put you over 6% interest. People are flabbergasted and can’t imagine paying twice the mortgage, but I’m here to give you some good news. The impact on your actual bottom line is not nearly as bad as you think.
If you purchase a home and have a $500,000 loan at 3%, your mortgage payment is $2,108 and change. If you double the interest rate to 6%, your mortgage payment is $2,997 and change. That’s an increase of about $900, or roughly 43%. That’s not fun to consider, but it’s hardly a doubling of payment as the interest rate doubles. The other thing to consider is that your interest payment in month one with a 6% loan is $2,500 vs $1,250 for a 3% loan. Interest for most home purchases is tax deductible, so although you jumped up $1,250 in interest payment, you can deduct it from your taxes so your actual after tax cost is not $900 more with the 6% loan. Consult your CPA on your exact situation, but realize first and foremost that doubling the interest rate produces a situation nowhere near a doubling of payment.
The other thing to consider is that in places where the market has reversed course, you’ll have a lower selling price for a home. If you wanted a home with a loan of $500,000 at 3% a year ago, you can likely get that same home for $450,000 at 6% now. The payment at 3% is $2,108 and the 6% is $2,697, and again, there are tax implications that make that $600 increase in payment even less of an issue.
Interest rates terrify all homeowners, current and soon to be alike, but they shouldn’t scare you that much. No one likes paying more than they need to for the same product or service, but when you consider the long term benefits of owning your own home, a temporary jump in interest rates should not dissuade you from realizing your dreams.
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