Imagine this: You spot your dream home but while you’re looking for a mortgage the price goes up 5%. Disappointed, you resume your house hunt, only to find that after a few more months home prices have jumped another 5%.
A 10% rise in a few months? That seems impossible in today’s weak housing market. In many parts of the country prices are still 20% below their peaks of a few years ago. There’s still a huge inventory of foreclosed homes in the market, and unemployment is still hovering around 10%.
How could prices rise so far so fast?
Actually, it’s not home prices that may go up, but the cost of buying a home, a critical distinction that’s easy to overlook. The cost includes the interest on the mortgage, and a one-point rise in interest rates can boost the cost of buying a home by more than 10%.
Average rates on 30-year fixed-rate mortgages have gone up about half a percentage point since the end of last year, to about 5.3%, and many experts think 6% is likely by the end of 2010.
Let’s look at the math, using the Mortgage Loan Calculator. With a 5% mortgage rate, every $100,000 borrowed would cost $193,257 over 30 years, counting interest and principal payments. Increase the rate to 6% and the cost would be $215,838, which is 12% more. (In fact, the additional $22,581 is 22.6% of every $100,000 spent on the home, so you could view the one-point hike as a 22.6% increase in the home’s cost.)
Many buyers don’t think of it this way because they focus on the sales price and whether they can afford the monthly payment. But, of course, that extra $22,581 is money that could be in your pocket. If you had a $300,000 loan, the one-point increase would cost you nearly $68,000.
The damage from higher interest rates is even more severe when you consider the “opportunity cost,” which is what you could make doing something else with your money. Increasing the rate from 5% to 6% boosts the monthly payment on a $300,000 loan by $188. The Savings, Taxes and Inflation Calculator shows that if $188 was invested every month for 30 years rather than being spent on the mortgage, you could have a nest egg of $221,000, assuming a 7% annual return.
For another way of looking at it, consider what a higher interest rate does to your ability to qualify for a loan. According to the Mortgage Qualifier, a household with $100,000 in income could buy a home worth $336,525 if the rate were 5%, but $309,680 at 6%.
By historical standards, a mortgage rate at 6% or less is pretty low, and anyone who really needs a new home should probably jump at the chance to lock in at today’s levels. But a rate increase that looks small can have severe long-term effects.
If you’re thinking of buying a home or refinancing a mortgage, it could pay to get moving. Use the mortgage search tool to track down the best deal. Bank of America (Stock Quote: BAC), for example, still has a 5% mortgage, while Wachovia (Stock Quote: WFC) and PNC Bank (Stock Quote: PNC) offer 5.125%.
—For the best rates on loans, bank accounts and credit cards, enter your ZIP code at BankingMyWay.com.