Two things could not have skipped the attention of people in 2013 – Stock market and Housing market. Whether you call it, Fed’s Quantitative Easing circus or real organic growth of US economy, both the markets grew at an unprecedented rate. S & P 500, grew by 26% and the hottest housing markets in US – San Francisco etc – grew by more than 20%. Considering the amount an investor put in and the inevitability to be in the market, I would say, housing market was the gold mine of the year (for sellers and real estate agents). By the way, actual Gold lost more than 25% in 2013.
If you are in the market as a buyer, I can understand what you would be going through now. Inventory shortage, bidding wars, difficulty in understanding and getting the mortgage might have been your day to day things. Among all the mess, it’s very easy to get carried away with the craze and momentum that’s baked into the market. If you could use, here is my two cents towards your home buying experience.
If you are wondering whether to buy now or wait, there is no answer that fits all. Depending on many factors like down payment amount, interest rates, credit history, your current rent etc. you would prefer one option to the other. However, if you are really not comfortable with the high prices and are concerned about the interest rate hike, I would ask you to look at the numbers I presented below.
In most of the top metros, the house prices reached the pre-recession – or pre-bubble if you prefer it that way – levels. In some metros, the median house prices are already higher than what they were at the peak before recession. That means, if you are thinking to leverage the recession, you already missed the boat – except in some markets like Florida (most of the cities), Phoenix, Las Vegas etc. So don’t let that feeling make you buy. The prices might still go higher but may not be at 20% per annum rate.
If raising interest rates are your concern, I would say, your concern is genuine. Interest rates for 30-yr fixed rate are currently between 4.5% to 5.5% depending on your credit score and other factors. It might go up to 6% although it might take some time. However, don’t let that fear make you put a large premium on the price. If are into bidding wars and the prices go up by 10% or more over the asking price, I would ask you to do some Math before you put a hefty premium.
The 8.3% formula
Here I introduce my 8.3% formula. Let’s say today you are ready to buy a house which is $500K. Your down payment is 20% ($100K) down payment and interest rate is 5%. Your monthly payment will be $2,147.29 and over the lifetime of the loan, you pay $773,023.14 in total (both are excluding property tax and insurance). Let’s say that the interest rates increased by 1% to 6% and as a result, house prices went down by 8.3%. The new price of the house would be $458,500 with 8.3% reduction. Consider that you are still up for putting $100K down payment – this would come to more than 20% on the decreased price of $458,500. Your monthly payment will be $2,149.39 and over the lifetime of the loan, you pay $773,780.41. This is almost same as you would pay in the first case. Check the below links to see these numbers.
This formula works well for any house at any price as long as you put 20% down payment and use the same amount with increased interest rate by 1% and decreased house price by 8.3%.
To put in plain words, raise in 1% interest rate is equivalent to 8.3% decrease in house price with 20% down payment. This down payment is to be 20% of the regular price. If you put lower down payment, the decrease in house price should be more to pay to get the same monthly payment. If the down payment is more than 20%, then you would required less than 8.3% reduction in house price to offset 1% hike in interest rate.
Let’s see the numbers for another scenario.
Original Price: $850,000
Down Payment: $170,000 (20%)
Interest Rate: 6%
Monthly Payment: $4,076.94
Total Amount over lifetime: $1,467,699.69
Decreased Case (Price decreased by 8.3% and Interest Rate increased by 1%)
House Price: $779,450
Down Payment: $170,000 (21.8102% of decreased price and 20% of original price)
Interest Rate: 7%
Monthly Payment: $4,054.69
Total Amount over lifetime: $1,459,687.93
Whether the house prices go down or not, is a different question. I am not into the predictions here. However, you can use this formula and see how the raise in interest could be offset by the decrease in housing prices.
Hope you have a pleasant buying experience.
PS: I am NOT a financial advisor. Everything you read on this site is just for information sake and I request you NOT to rely on this info solely.