Should I Wait for Lower Interest Rates if Sales Prices Increase?
Whether the sales price is more important than the interest rate depends on your perspective. All real estate is local. This means whatever is happening in your local market in Phoenix, for example, could vary wildly from, say, the market in Manhattan. This complexity makes it nearly impossible to time the real estate market, but you can try to take advantage of the way the market moves.
You can't always predict fluctuations in the market. But you can watch it move and learn patterns. And generally, the rule of thumb is when interest rates go up, sales prices move down to compensate. This has held relatively true over the years, though there are exceptions. So this leads to a natural question: Is it worth waiting for lower interest rates if home prices go up?
Rising Sales Prices vs. Declining Interest Rates
Let's look at an extreme example to see how this might work. Note that interest rates won't normally jump this much in a short period.
Say you are comparing a home in Phoenix that was worth $240,000 and your interest rate is 4.5%. If you were buying in a declining market and waited until that price fell to $210,000 but rates went up to 6.5%, you might be better off buying at a higher price.
See how they compare:
- Payment on an 80% LTV mortgage for a $240,000 home at 4.5% is $972.84.
- Payment on an 80% LTV mortgage for a $210,000 home at 6.5% is $1,061.87.
Put another way, if you paid $30,000 more for the home by paying $240,000 and lived in that home for 30 years, by the time you paid off your loan, you would have paid a total of $398,220.89 (including your down payment).
If you paid $30,000 less by paying $210,000 but paid on the higher interest rate for 30 years, by the time you paid off your loan, you would have paid a total of $424,274.74 (including your down payment). In this instance, it is not better to pay less in exchange for a higher interest rate.
The chart below illustrates the relationship between declining sales prices and rising interest rates.
Loss in Sales Price With Each .5% Interest Rate Hike
Now, let's look at more realistic short-term changes. The amortization of most mortgages is for 30 years, and rates tend to fluctuate by a quarter or half of a percent. Here's how much home you could afford with rate fluctuations of 0.5%. and a down payment of 20% of the sales price, assuming you want to keep your payment (principal and interest) around $975.
- $240,000 X 80% at 4.5% interest equals a payment of $972.84
- $226,260 X 80% at 5.0% interest equals a payment of $971.69
- $214,062 X 80% at 5.5% interest equals a payment of $972.34
- $202,500 X 80% at 6.0% interest equals a payment of $971.27
- $192,188 X 80% at 6.5% interest equals a payment of $971.80
You can see that a 2% increase in an interest rate would lose you about $50,000 of purchasing power in this price range. If you doubled the sales prices in this example, you would lose about 100,000 of purchasing power with a 2% spread in interest.
The Risks of Predicting
You can see why interest rates are a huge factor for many first-time home buyers. If you are stretched too close to the top end of your price point and rates go up, you might not be able to buy that dream home you want because you will no longer qualify for that sales price. Conversely, if rates drop, you might be able to afford a significant jump in price.
That being said, it can be tricky to predict interest rate changes. If you wait for rates to drop, you could miss out on the home you really want. Be sure you know what you're risking if you try to predict where interest rates will go next.
Bank for International Settlements. "Interest Rates and House Prices in the United States and Around the World." Accessed April 7, 2020.
St. Louis Fed. "30-Year Fixed Rate Mortgage Average in the United States." Accessed April 7, 2020.