Should I Buy Now And Avoid Higher Interest Rates?

This is a common question I get. Potential home buyers will worry that rates are going to spike, after all, “how long can they stay this low,” goes the logic. So some buyers assume they should buy now, at any price, and avoid a future rate increase. I am not sure how long rates can stay low, they have been low for almost two decades in Japan! But, I thought for fun, we’d look at some different numbers. Keep in mind the below are based off of broad assumptions of my own:

Buying a three bedroom house today, in the Washington DC Metro area in a good neighborhood, let’s assume costs $700,000. Further, let’s say the buyer is ecstatic to get a rate of 4.875% on a 30 Year Fixed Rate mortgage, and that they have a 20% down payment. Should the buyer be ecstatic?

1. $700,000 x 80% = $560,000 mortgage
$560,000 mortgage @ 4.875% = $2963/month (not including taxes and insurance)

2. Let’s assume interest rates jump a little in this next scenario, and go back to a norm we have seen many times in the last few decades around the mid 6′s. That would mean people would not want to buy? Would it certainly push real estate values down? Here are some hypothetical #’s:
$560,000 mortgage @ 6% = $3539/month (but prices would not hold at $700,000, so let’s do a few other calculations).

3. $600,000 home value
$480,000 80% loan
$480,000 @ 6.5% = $3033/month

Would property values fall this much if rates jumped 1.5%? This payment is about the same as the 4.875% rate. So would you rather buy a cheaper house at a higher rate? At least your cost basis is much lower, and your chance of future appreciation is higher. But will prices ever really sink that far? And are you wasting your time waiting for them to do so? Do rates inevitably have to go higher thanks to the deficit and our government’s inability to spend within a budget (which they implore us to do personally), and if so, will housing prices inevitably have to drop as a result? I am not sure anyone has the answers, but these are interesting questions.

Let’s try another one:

4. Let’s assume interest rates have ‘really’ spiked:
$350,000 home value
$275,000 80% loan
$275,000 @ 10% = $2413/month

This monthly payment is much lower than the other scenarios. Would housing prices get cut in half if rates doubled? I am not saying they would or would not, I am just fooling around with some mathematics. Can rates really get to 10%? Well, they were over 13% when I got in the mortgage business, which was only back in 1986! And I have written numerous mortgages in the 8% – 10% range, and remember when rates first fell to 6.00% to 6.50% and people felt like that was cheap money!

What we can clearly deduce is that the price of the house is as important, or more important, than the rate you finance it at. After all, if you get stuck with a 8% rate, chances are high you’ll refinance at some point. Once you pay for a house, you cannot change the acquisition price.

I think it is also fair to ask, do we need rates to stay low forever to keep real estate values propped up? Who really knows what happens if rates spike, but it poses an interesting question.