Several people have asked recently whether they should wait a couple of years before plunging into the housing market because they believe housing prices may drop. It is almost impossible to time the market, so in general, my advice is to buy a house when you need and can afford one.
However, it’s interesting to investigate where the tipping point is between housing prices and interest rates. There is good reason to believe that rates are going up soon, and rate increases put downward pressure on housing prices. Let’s run a couple of scenarios.
Today, we have a house worth $500,000. With a 20-percent down payment, your loan amount would be $400,000. Let’s say you choose a 30-year, fixed-rate mortgage and are able to secure a 4 percent interest rate (randomly chosen, I am not quoting current rates). In this case, your monthly payment would be about $1910.
Take that same house two years from now. Let’s imagine that interest rates have gone up to 6 percent, and in response, the price of housing has dropped by 20 percent. This house is now $400,000. If you invest the same $100K as a down payment and get a 30-year, fixed-rate loan, your monthly payment will be about $1799, which is $110 lower than the present-day payment for the same house.
So, if you wait two years, your savings is only $110 a month. If housing prices drop by the same amount but rates go to 6.5 percent, your savings is only $13 per month. (As it happens, the breakeven for this scenario here is a rate of 6.57 percent.) My point is this, you won’t save much by waiting, and you’ll have spent a fair chunk of change on rent payments that do not help you build equity or save on taxes.
Let’s run another scenario. What if home values drop by 15 percent and rates go up to 6 percent? Now you’re paying $425,000 for the house. After your $100,000 down payment, your loan amount is $325,000. With a 30-year, fixed-rate mortgage, your monthly payment $1949, which is $40 more than if you’d bought two years ago. If rates go to 6.5 percent, your monthly payment becomes $2054, which is $144 more per month if you’d bought now. The breakeven point interest rate in this scenario is 5.8 percent. So, if you think interest rates are likely to go up to more than 5.8 percent and prices are likely to drop by 15 percent in the next couple of years, you should buy today.
Obviously, there are many scenarios: housing prices and interest rates are unpredictable, and the combination of increases and decreases will provide different results. The point is, just because you think housing prices will drop doesn’t mean you should wait to buy a house. Talk to you Realtor and have them run the numbers.
I do think it’s reasonable to assume that rates will rise soon, given that the Federal Reserve has already said they plan to raise rates two or three times this year in response to rising inflation. For 2021, inflation was at about 6 percent and the inflation for December was the highest in 40 years. Clearly, much of this is COVID-related, but no one knows how 2022 will go.
As a reminder, investing in real estate is generally best when you plan to hold property for an extended period of time. Keep in mind that even if you are transferred to Timbuktu, you may not have to sell. You can generally convert your primary residence into investment property, and if you do, you may realize some significant tax advantages.
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.