Mortgage rates in 2010 hit historic lows, but rates have not driven buyers to the housing market en masse. Why? Some continue to fear that home values will continue to fall into next year. But with rates possibly rising in 2011, you may still be better off buying now and paying 5%-10% more for your home than take a chance that rates may be about three-quarters of a percent higher in 2011.
For the past several months, mortgage interest rates have been at historically low levels and the Mortgage Bankers Association predicts that the average 30-year fixed rate mortgage will average 4.4% in the fourth quarter 2010. The MBA also predicts that the average mortgage interest rate will rise to 4.7% in the first quarter 2011 and barring any significant announcement by the Federal Reserve, Jay Brinkmann, chief economist of the MBA, predicts that mortgage interest rates will average 5.1% by the end of 2011.
Taking a simple mathematical approach and assuming a current $175,000 home purchase price, a 30-year fixed rate mortgage will cost a buyer over $406,400 over the term of the loan at 4.4% (future value of the purchase price, 360 monthly payments, 4.4% simple interest). At 5.1%, the same purchase details raise the total of interest and principal payments to over $524,600. That’s $118,000 in reasons to buy now, assuming the home price does not change.
Many believe that home values will continue to decline through the next year. And there are many reasons to believe that there is a high probability that home values, at least in some locations, will continue to decline due to the sizeable number of foreclosures in process, the slowed foreclosure process due to paperwork issues, and the large number of borrowers who are delinquent on their mortgages. More homes out in the market under distressed sales conditions could serve to drive home values lower … and keep prospective buyers fearfully on the sidelines. But it might not be wise to sit on the sidelines …
So, if home values fall another 5% in 2011, but mortgage interest rates rise to 5.1%, what happens to the $175,000 purchase example? First, the home price falls to $166,250 but the 5.1% rate costs the prospective buyer almost $78,000 in additional interest, net of the smaller principal, over the 30-year life of the loan.
And what if home prices fall by 10%? The purchase price falls to $157,500. At the higher 5.1% rate over 30 years, the purchase costs the buyer more than $37,000 in additional interest, net of the lower principal. Is it worth waiting on the sideline if rates are going to rise in 2011?
And what if home values remain flat to current 2010 values but interest rates do not rise as far as predicted by the end of 2011? After all, in some locations, home values have shown some stability. Let’s assume the increase in mortgage rates is not even half what the MBA predicted by year-end, but rather the average for the year is a more benign 4.7%? The same $175,000 home will cost about $47,000 in additional interest over the 30-year life of the loan.
So, prospective buyers need to ask themselves if they can afford to wait. If the right home comes along, many prospective buyers might just find out that they can’t ….