Price vs Interest Rate

Buyers in todays residential housing market often consider waiting for a lower price as the best way to minimize monthly loan payments. Thus, many buyers may not be giving adequate consideration to currently low interest rates which may be even more important in keeping costs down. As we pointed out recently, distressed properties (foreclosures, short sales, etc) are not always bargains. A similar assumption, that a lower price reduces costs more than taking advantage of historically low interest rates, may also be in error. While both price and interest rates are important, a half percent increase in interest rates can more than negate a 5% price reduction.

A simplified example illustrates this: Tom and Sue wish to purchase a house priced at $400,000. They have 25% down and need a loan of $300,000. They can obtain that loan now at a 4.5% interest rate requiring a payment of $1,520/mo. They decide to wait instead, expecting the price to come down another 5%, so the loan amount will be $285,000. If they are able to purchase at the lower price and the interest rate does not change, payments will be $1,444/mo. However, if interest rates rise just to 5% while waiting, even if they are able to buy at their price, payments will be $1,530/mo, or $10/mo higher than if they had not waited. If the lower price does not materialize while waiting and the interest rate increases to 5% their payments will be $1,610/mo, or about $90/mo more than they would have paid at the original price and interest rate. This does not even address the greater total amount of interest which might be paid over the life of the loan.

While half a percent may seem a large increase in interest rates, it is worth noting rates have increased about that much in the past month or two. What interest rates will be even a month from now is uncertain, but it appears rates are likely to increase by fits and starts to significantly higher levels. Conversely, while housing prices may go lower, widespread price reductions have slowed to a relative crawl. We suggest buyers who are waiting or are considering waiting for prices to fall further, carefully evaluate the relative impact of lower price versus higher interest rate. By all means negotiate price, but it may be better for your finances to do it now while you can still take advantage of the lower interest rates still available rather than wait.