Most people don’t buy real estate very often, so it can be hard to know when to buy or which loan makes the most sense. Lately, the housing market has been red hot, which means home prices are going up. This is great for sellers, but it makes buyers nervous. A young woman who is in the market to purchase a home recently asked me, “Would you buy a house in this market, or should I wait?” To which I replied, “Not only would I buy now—I am buying now. I currently have one in escrow.”
If interest rates were high, I’d say it’s a seller’s market, but because we continue to have historically low interest rates, this is actually a buyer’s market, too. Here’s how this works.
To keep the math simple, let’s say you need a $100,000 loan to purchase a home. On a 30-year fixed loan with an interest rate of 3 percent, your monthly payment would be $421.60. If housing prices dropped by 10 percent, you would now only need a loan of $90,000.
However, the financial pressures that lead to lower housing prices are the same pressures that will almost certainly lead to increased interest rates. Let’s say interest rates go up to 6 percent, still a relatively low rate. With an interest rate of 6 percent on a $90,000 loan, your monthly payment is $539.60. That’s $118 more per month. So, would I buy now? Yes, I would.
Once buyers realize now is a good time to buy, the next question is how to get the best loan. Let’s say you’re buying a $500,000 home. You have saved $100,000 for a 20 percent down payment, which will allow you to get a 3.375 percent interest rate. Then, the lender throws you a curve ball and says, “If you can put down $125,000 on a 30-year fixed loan, we can decrease the interest rate by 0.375 percent.”
So, you have two options: a $400,000 loan at 3.375 percent interest or a $375,000 loan at 3 percent interest. Should you beg, borrow, and steal to get that extra $25,000 to bring the interest rate down? (Well, you shouldn’t steal, but you might consider begging or borrowing—we call that kind of borrowing a gift from parents.)
The monthly payment on the $400,000 loan at 3.375 percent will be about $1,768. The monthly payment on the $375,000 loan at 3 percent will be about $1,581. That’s a savings of $187 per month, not to mention the savings on a few fees and costs associated with the loan.
A lower monthly payment is enough to inspire some buyers to find the extra $25,000. For those who are still on the fence, let me put this another way. If you think of that $25,000 as a loan to yourself, the return on that amount (because of the differing interest rates) is about 8.22 percent. You’d be hard-pressed to find an investment that will guarantee an 8 percent return with almost no risk.
Since money doesn’t grow on trees, you may need to go for the bigger loan. But if you are trying to decide between putting that extra $25,000 into your home or investing it elsewhere, my money would be on real estate.
If you have questions about property management or real estate, please contact me at firstname.lastname@example.org or call (707) 462-4000. If you have an idea for a future column, share it with me and if I use it, I’ll send you a $25 gift certificate to Schat’s Bakery. Dick Selzer is a real estate broker who has been in the business for more than 45 years.