Along with the COVID-19 pandemic came lower interest rates, coupled with a strong demand for housing. An interest rate determines how much money must be paid in a mortgage payment. The higher the rate, the higher the interest payment. Armed with this basic understanding, a few average interest rates, and an understanding of home pricing over time, you might end up agreeing that buying now really does mean buying more.
Average Interest Rates Over Time
| DECADE | INTEREST RATE |
| 1990’s | 8.12%* |
| 2000’s | 6.29%* |
| 2010’s | 4.09%* |
| 2020 | 2.96%** |
** overall average on 8/13/2020 for a 30 year fixed rate mortgage
source: http://www.freddiemac.com/pmms/#
We will give calculations from https://benchmark.us/resources/mortgage-calculators/ based on the table above and the assumptions below.
- Home price: $248,857 (average home value index*)
- Down payment: $10,000 (4.02%)
- Loan amount: $238,857 ($248,857 – $10,000)
- Term: 30 year fixed rate mortgage
* from https://www.zillow.com/home-values/ sourced on August 24th, 2020 at 1:00pm CST
Let’s Do The Math
We are ignoring closing costs, taxes, insurance, and any HOA fees, and focusing only on the real monetary impact that interest rates have. This article is intended to help you understand the power of interest, and is not intended to give a comprehensive guide to the overall cost of buying or refinancing a home.
| Average Interest Rate | Decade | Monthly Payment | Total Interest |
| 8.12%* | 1990’s | $1,772.67 | $399,304.36 |
| 6.29%* | 2000’s | $1,476.90 | $292,828.15 |
| 4.09%* | 2010’s | $1,152.77 | $176,139.46 |
| 2.96%** | 2020* | $1,001.89 | $121,821.68 |
** overall average on 8/13/2020 for a 30 year fixed rate mortgage
source: http://www.freddiemac.com/pmms/#
Remember, the interest rates are the average for a span of time. Actual rates are determined by a number of factors, like credit history, credit score, debt to income ratio, and employment history, among other factors.
As the table above clearly shows, the lower the interest rate, the more money you save. Sure, an extra $150 a month is really handy. Over the life of the loan, that’s over $55,000! However, what if you have a target payment in mind, and you want to maximize your budget? How much house can you afford?
Reading Between The Lines
Let’s say, hypothetically of course, that you have a budget of $1,000 for Principle and Interest every month, but your interest rate is 4.09% (like in the 2010’s). If a rate of 2.96% allows you to buy a house worth $248,408 with your $10,000 down payment, then how much house could you buy with a higher interest rate of 4.09%?
The cost of a 1.13% rate difference, visualized
At an interest rate of 4.09% and a $10,000 down payment, to reach the monthly Principal and Interest budget of $1,000/mo, the maximum home price you could afford is $217,204. That’s over $30,000 less than what you could buy with an interest rate of 2.96%! That’s a rate difference of 1.13%, and it reduces your buying power by more than $30,000. Just think about that.
| INTEREST RATE | DOWN PAYMENT | MONTHLY PRINCIPAL & INTEREST | MAXIMUM HOME PRICE |
| 2.96% | $10,000 | $1,000 | $248,408 |
| 4.09% | $10,000 | $1,000 | $217,204 |
The average Zillow Home Value Index increased by 4.1% over the last year (https://www.zillow.com/home-values/, accessed August 26th, 2020), which means the average home was valued at $239,055.72 one year ago. Today, the average home value is $248,857, or $9,801.28 more expensive.
| YEAR | AVERAGE HOME PRICE |
| 2019 | $239,055.72 |
| 2020 | $248,857.00 |
| difference | $ 9,801.28 |
The Home Price Index is up $72,117 in 10 years
https://fred.stlouisfed.org/graph/?g=uMkV S&P Dow Jones Indices LLC, S&P/Case-Shiller U.S. National Home Price Index [CSUSHPINSA], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CSUSHPINSA, August 26, 2020.According to the chart above, from June 2010 to June 2020, the S&P/Case-Shiller U.S. National Home Price Index increased by $72,117 from $147,702 to $219,819. According to the S&P CoreLogic Case-Shiller Composite, the last 10 years have shown an annualized increasing National Home Price NSA Index of 4.06%. This means that, on average, the home price index has increased by 4.06% every year for the last ten years! Download the report to see for yourself.
What would this mean if this annualized rate of increase continues for the next two years? Of course, many economists project a minimal change over the next year, but projections aren’t perfect, and no-one has projected for the year after. The only thing about the future that we are certain of is that the future is unpredictable. Hypothetically, however, what if this annualized 10 year rate of increase were to continue into the next two years?
Two Years of 4.06% Hypothetical Annual Appreciation
| YEAR | AVERAGE HOME PRICE | RATE OF ANNUAL APPRECIATION |
| 2020 | $248,857 | 4.06% |
| 2021 | $258,961 | 4.06% |
| 2022 | $269,474 | 4.06% |
The table above shows the calculated totals based on the rate of appreciation. Let’s calculate a 4.06% appreciation from the current average home price of $248,857.
$248,857 x 1.0406* = $258,960.59
(* effectively multiplying by one plus 4.06%)
This represents an increase of $10,103.59 in a single year! Let’s calculate the second year. With the new hypothetical average home price of $258,960.59.
$258,960.59 x 1.0406* = $269,474.39,
(* effectively multiplying by one plus 4.06%)
This represents an increase of $10,513.80 over the second year, and $20,617.39 more than the current average home price! If you remember that 1.13% difference in interest rate resulted in being able to afford over $30,000 less home value, just imagine the opportunity cost if rates were to increase just 1% along with an inflating home price index. We have written about the cost of waiting before. This article is strictly about the power of interest rates, however, and given that a slight increase in the interest rate dramatically reduces your buying power, the title begins to make sense.
What This Means For You
Buying when the average interest rate is below 3% allows you to buy a more valuable home than you could if interest rates were only slightly higher. With home prices on the rise over time (assuming historical trends continue), this could be a great opportunity to not only become a homeowner, but to potentially improve your family wealth.
At Benchmark, we are committed to listening to your goals to match you with a mortgage to fulfill your home buying vision while setting you up for future success. To learn more, Contact your local Benchmark branch. Contact us today for personalized information. Call me yourself or request a call from me. WeI would be honored to provide you with our famous excellent service.
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