If You Have Financial Flexibility, You Can Buy a Home Even with High Interest Rates
Purchasing an Affordable Home Should Be Your Priority
When purchasing and owning a home, there are two important variables that affect your mortgage expenses: home price and interest rate.
Home price is a clear factor that determines how much you’ll pay during the loan term, but interest rates also play a crucial role in your total mortgage costs. With both prices and interest rates being high in the current situation, it’s natural to hesitate about buying a home. That’s why home buyers are always torn between home prices and interest rates. Should you buy when home prices drop, or should you buy when interest rates drop?
If mortgage interest rates show no signs of falling for a considerable period, is it better to buy a home when prices drop slightly? Or is it better to wait longer and buy an expensive home at lower interest rates, even if home prices rise due to competition? To answer this question, it’s easier to understand by calculating the relationship between interest rates and home prices numerically. This can be seen in the relationship between mortgage payments and home prices.
The Relationship Between Home Prices and Mortgage Interest Rates
Deciding whether to prioritize low home prices or mortgage interest rates is more than just a simple mathematical question.
This is because housing markets tend to show an inverse correlation between home prices and mortgage interest rates. Specifically, home prices tend to be lower when mortgage interest rates are high, and home prices generally rise when mortgage interest rates are low. When mortgage interest rates are high, demand for home purchases decreases, and when mortgage interest rates are low, demand for home purchases increases. When demand increases, home prices rise, and when demand decreases, home prices fall.
The relationship between mortgage interest rates and home prices is directly related to the economic principles of supply and demand. In this case, mortgage interest rates affect housing demand in the housing market. Low mortgage interest rates generally mean increased demand for housing, which leads to home sellers setting higher home prices and home buyers offering higher prices. On the other hand, when mortgage interest rates rise, demand for housing may decrease, and home sellers lower prices to attract potential buyers, or home buyers offer lower home prices, causing home prices to fall.
Interest Rates and Home Prices Affecting Home Buying Power
Mortgage interest rates and home prices affect home buyers’ ability to purchase homes. Calculating the affordability of a home depends on three aspects of home transactions: down payment, monthly mortgage payment, and the lifetime cost of home financing (amortization). The lifetime cost of home financing varies depending on what conditions you choose for your home purchase.
Down Payment
General home mortgage loans require a down payment. Home buyers who want to avoid paying private mortgage insurance (PMI) must put down at least 20% as a down payment, but mortgage lenders can reduce this to as low as 3% for conventional loans.
According to research by online real estate information company Realtor.com, the average down payment in Q1 2024 was 13.6%, with a median value of $26,000. Buying a home with a lower price but higher interest rate could result in a cheaper down payment.
For example, let’s assume you bought a $440,000 home when mortgage interest rates were high. You could put down a 20% down payment of $88,000 and get a 30-year fixed mortgage at 7.3% interest rate.
However, if you had waited for mortgage interest rates to fall before buying a home, the same home might now sell for $600,000. The 30-year mortgage could have a lower mortgage interest rate of 5.5% now because you waited, but to avoid mortgage insurance (PMI), you’d need to pay a 20% down payment of $120,000.
When mortgage interest rates fall, demand for home purchases increases and home prices rise further, requiring larger down payment amounts.
Monthly Payments
Monthly mortgage payments depend on several factors, including the home mortgage loan amount and loan interest rate. If you bought a $440,000 home with an $88,000 down payment and 7.3% mortgage interest rate, your monthly payment for mortgage principal and interest would be about $2,415.
If you waited until mortgage interest rates dropped to 5.5% and then bought a home for $600,000, you’d need to come up with an additional $32,000 to pay the 20% down payment of $120,000. If you can afford the higher down payment, your monthly mortgage payment would be about $2,716, which means you’d pay about $300 more per month than if you had bought a home at a lower price with a higher mortgage interest rate.
However, assuming you can’t afford the $120,000 down payment, if you buy a home for $600,000 with an $88,000 down payment, you’ll need to pay additional mortgage insurance (PMI) until you accumulate at least 20% equity in the home. If you pay 0.5% for private mortgage insurance (PMI), your monthly mortgage payment including mortgage insurance for the first 50 months would be about $3,120.
After 50 months, you’ll have built up 20% equity and will no longer be responsible for mortgage insurance (PMI). Then your monthly payment drops to $2,908 for the remainder of the loan term. In this case, waiting for mortgage interest rates to be reduced results in monthly payments that are $500-700 higher.
Lifetime Loan Cost (Amortization)
While you may feel the burden of down payment and monthly mortgage payments in the short term, the lifetime cost of the loan is also an important factor in home affordability. This is where interest rates can make a big difference.
For example, a $440,000 home with a down payment of $88,000 and an interest rate of 7.3% for a 30-year mortgage costs an additional $526,756 in interest over the loan term in addition to the loan amount.
However, if you wait until mortgage interest rates drop to 5.5% and home prices rise to $600,000, the lifetime cost changes. For a 30-year fixed mortgage with $88,000 down and having to pay mortgage insurance (PMI), the lifetime loan cost is about $545,214, divided into $10,666 in mortgage insurance (PMI) costs and $534,548 in lifetime interest. In this case, buying a home at a lower price even with a higher mortgage interest rate is a better choice, and you could save over $28,000 over 30 years.
However, if you can afford the 20% down payment of $120,000 and don’t have to pay mortgage insurance (PMI), the lifetime interest paid on a 30-year home loan at 5.5% interest rate is only $501,140. You can save nearly $16,000 in interest over the lifetime of the loan, and when you calculate the money saved from mortgage insurance (PMI), you can save $26,666.
Total Home Price
You can compare the total home price, which combines all individual factors that add up to the total cost of home ownership: mortgage interest rate, home price, down payment, and mortgage insurance (PMI).
- $440,000 home, 7.3% mortgage interest rate with 20% down payment ($88,000)
- $600,000 home, 5.5% mortgage interest rate with 20% down payment ($120,000)
- $600,000 home, 5.5% interest rate with 14.7% down payment ($88,000)
In this case, buying a cheaper home with a higher mortgage interest rate can save you money on down payment, mortgage insurance (PMI), monthly mortgage payments, and total costs.
However, the numbers vary depending on the exact interest rates and home prices. Lower home prices don’t always beat lower interest rates, especially when there’s no 20% down payment in both scenarios.
Home Price Matters More Than Mortgage Interest Rate
Is it better to lower home prices or to lower mortgage interest rates? Directly speaking, is it advantageous to buy a home now even with high mortgage interest rates, or is it advantageous to wait until mortgage interest rates fall?
The obvious answer is to buy a home at the cheapest price with the lowest mortgage interest rate. However, since mortgage interest rates and home prices rarely align perfectly, you must choose a situation where one is advantageous.
In particular, mortgage interest rates are mostly beyond the control of home buyers. You can get lower interest rates with a high credit score, but you generally can’t exceed the range of market interest rates. In other words, mortgage interest rates are not a condition you can choose.
However, home buyers can control the price of a home to some extent. By choosing homes with lower listing prices, you can afford higher down payments, avoid mortgage insurance (PMI), and build home equity faster. Better interest rates can lower total home costs over time, but by choosing affordable homes regardless of current interest rates, you can lower home costs, which is realistically most advantageous.
Many people buy homes even when mortgage interest rates are high. The reason is that potential home buyers who can afford down payments, closing costs, and monthly mortgage payments can definitely proceed with home purchases even when mortgage interest rates are high. If there’s no compelling valid reason to buy a home immediately, you can wait in case mortgage interest rates or home prices fall. However, timing the real estate market is difficult, so you need to have some understanding of housing market conditions and mortgage interest rate predictions.
Refinancing high mortgage interest rates will probably take a little more time. Refinancing can be a good way to lower mortgage interest rates if you bought a home when mortgage interest rates were high. When refinancing a mortgage, it means getting new financing that replaces your current mortgage loan with a new loan. If you bought a home with high mortgage interest rates, you can take advantage of refinancing when lower interest rates come down.
When refinancing, you have to pay closing costs again, so realistically you need at least a 1.5 percentage point difference in mortgage interest rates to achieve savings. For mortgage interest rates to fall 1.5 percentage points from current levels, it would probably take until the second half of next year.
New Jersey Realtor Richard Choi
New Jersey Best Realtor Richard Choi
