Is it better to purchase a home with a high price but a low interest rate or a low price with a high interest rate?

Question of the week: Is it better to purchase a home with a high price but a low interest rate or a low price with a high interest rate?

Answer:  This question was posed earlier in the week from Adam, who purchased his first home a few years ago with his wife using his VA benefits.

It is an interesting question and the answer depends on several factors, including timing, math and personal wants and needs.

By asking this question in the way he has, Adam is commoditizing the home into a financial question. Long time readers of the WR&MU know that my opinion is that a home purchase should not be made from a return-on-investment perspective but rather from establishing a home for your family that is affordable, in a neighborhood that suits your means and needs, and for the long term. Yes, in most of Southern California home prices will likely increase during your time of ownership, giving you a return on your initial investment, however that gain should be secondary to quality of life gains you should expect to receive from homeownership.

“Better” therefore becomes a relative term to each family when considering the answer to the higher price/lower rate vs. lower price/higher rate proposition.

For my response, I am assuming the question is in regards to purchasing the same house, or very similar one in regards to what the value would be. My reply to Adam was as follows.

If you are asking, were you better off to buy your home at a lower price and higher rate in the past than you could today, the answer is yes, because you own the home, have seen it appreciate in value and later were able to refinance to a lower rate and payment. So not waiting for lower rates has benefited you.

If you are asking if today, in the current market, is it better to purchase a home with a higher price and a lower rate, the answer is yes because, again, you own the home, which will appreciate over time and you own it with a very low rate saving you money and the need to refinance in the future.

If you are asking for the future, the question begs the next question of, “will prices go down as rates go back up?”

My opinion is that when this real estate market cools, we will not see much of a decline in prices, if any, depending on the area or region where the home is located. Cooling off will mean less of a feeding frenzy created by fewer properties on the market than buyers chasing the limited supply of housing. We will see more of an equilibrium and “normal” market. This will slow price growth, may stall it to almost zero, but in most of our region I see little evidence of prices dropping much or at all, absent a big down turn in economy and job losses for those with incomes able to afford homeownership. The lack of job and income losses for most of those with incomes able to afford homeownership is what has created the current real estate market pushing prices higher and make it very difficult for buyers to have their offers accepted due to the competition.

My medium to long-term outlook is home prices stabilize as higher values as rates go up, which means the same home today will cost more in the long run due to higher mortgage payments.

Some quick math for those, like me, who benefit from numbers.

High price/low rate, assuming 20% down payments:

Price $650,000

Loan Amount $520,000

Rate 2.875%

Monthly payment = $2157

Low price/high rate (May 2019—assuming about 18% price increase)

Price $550,000

Loan Amount $440,000

Rate 4.00%

Monthly payment = $2100

As you can see the lower price/higher rate is a better financial proposition, for about the same monthly payment your cash to close is a lot lower, $20,000 in down payment plus savings in closing costs of around $2-3,000.

Looking forward to the implication of Adam’s question that prices will drop in the future and is it better to wait to purchase until they drop. I cannot see a drop in values of up to 18% in the future, again absent a catastrophic event resulting in large scale job losses.

However, let’s say prices drop 5% and rates go back to May 2019 levels:

Price: $617,500

Loan Amount: $494,000

Rate 4%

Monthly payment = $2358

As you can see, the down payment for the lower price is only $6500 less than the higher value of $650,000. Because of the rate increase, the monthly payment is about $200 more per month.

My position on when the best time to purchase a home has always been, when you can afford to do so; especially in Southern California where over time residential real estate has consistently shown growth in value over time, making it more expensive for you to purchase the same home the longer you wait.

If you, or someone you know is considering purchasing their new home, please contact me to explore the options and opportunities for homeownership.

Have a question? Ask me!

Economic data released today showed an expected slow down in consumer spending in April and a decline in personal income. The contractions were expected as March saw large increases in both spending and income due to the $1400 checks Washington sent most families. April did see inflation continue to increase, prices rose 3.6% on an annualized basis, the highest rate since 2008.

Rates for Friday May 28, 2021: Investors are sitting tight on fixed rate investments, such as bonds and mortgages, and as a result we see rates flat from last Friday.

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS FOR PURCHASE TRANSACTIONS:

30 year conforming                                         2.75%  Flat

30 year high-balance conforming                   2.875%  Flat

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

Growing up in the Midwest and East Coast, where there are four seasons, Memorial Day weekend meant the opening of swimming pools and was the official start of summer. Family cookouts and gatherings were the tradition.

This weekend we will recreate some of that at the Smith house as my older sister is visiting for the weekend to see her nieces, and my brother and family will be here Sunday for family barbecue.

I hope you and your families are able to get together, enjoy time together without mumbling through masks, and as, if not more, importantly hugging each other.

Besides protecting us from the Covid-19 coronavirus, the biggest benefit of the vaccines is their enabling us to enjoy each other’s smiles and physical contact with hand shakes and hugs. I look forward to more of each as we all feel more and more comfortable engaging with others.

Have a great week,

Dennis

Past Weekly Rate & Market Updates can be found on my blog page at my website www.DennisCSmith.com/my-blog