Think fast: When you buy a home, which would you rather have, a low price or a low mortgage rate?
These days, it’s an issue worth thinking about. Mortgage rates have inched up recently, but home prices are still way below their peak of a few years ago. As long as the combination of home price and mortgage rate produces an acceptable monthly payment, does it really matter how you get there?
Well, it can.
Imagine you had your eye on a $300,000 home that could be bought with a 20% down payment, the standard these days. This week, the average 30-year fixed-rate mortgage charges 4.549% interest, according to the BankingMyWay survey. So you’d pay $1,223 a month on a $240,000 loan, the BankingMyWay Mortgage Loan Calculator says.
A week earlier, 30-year loans averaged 4.290%, and you’d have paid $1,186 a month to borrow the same amount, $37 less.
That’s not a crushing difference – the price of a modest dinner out. But it starts to look worse when you realize that this tiny rate increase will cost you $13,320 during the life of the loan. If you invested that money at an 8% return, you could have more than $52,000 after 30 years. Even if you assume inflation would chew at that total, it’s not a sum to ignore.
To offset the difference, you could make a lower offer on the home. To keep the payment at about $1,186 a month at today’s slightly higher mortgage rate, you’d get a mortgage of $233,000 rather than $240,000. If you assume you could still make a $60,000 down payment, you’d pay $293,000 for the home instead of $300,000.
During the next 30 years, the total payments would be about the same regardless of whether you took the smaller loan at the higher rate or the bigger loan at the lower rate – about $427,000. That stands to reason since the monthly payments are nearly identical.
But if you took out the smaller loan at the higher rate, paying $7,000 less for the home, you’d be $7,000 richer after you sold it.
All that savings would come at the beginning, through the lower down payment. If you invested that $7,000 at 8% you’d have more than $70,000 after 30 years.
In real life, things probably wouldn’t work out so neatly. The seller, for example, would resist your demand to knock down the price to offset a rate hike. Maybe you’d end up splitting the difference, maybe not. But there are two lessons to take from the example.
First, don’t shrug off an apparently small rate increase without figuring what it could cost in the medium- to long-term. Many home buyers focus only on monthly payments, without thinking about the comparable savings of a relatively minor change in a home’s sales price.
Second, when you sign a contract to purchase a home, be sure to make the deal contingent on receiving a mortgage at or below a rate with which you are comfortable.
Obligating yourself to take on a rate that’s too high could cost you a small fortune over time. And of course, specifying a maximum rate that’s unrealistically low would reduce your chances of getting a loan, a risk that might make the seller reject your offer.
—For the best rates on loans, bank accounts and credit cards, enter your ZIP code at BankingMyWay.com.