Interest rates - WHY YOU SHOULD CARE

We've all heard the claims lately that low interest rates are the reason why you should buy a house right now, even though times are uncertain.

As a Roaring Fork Valley homeowner or potential buyer, you might be wondering: HOW DOES THE LOW INTEREST RATE AFFECT ME?  Well, the interest rate applied to your mortgage might have bigger consequences than you think, so let's take a look at how interest rates change what your money can buy.

The graph below shows the evolution of interest rates between 1971 and today.

Source: Value Penguin

Now, we'll break down what a $2,000 per month mortgage payment will get you depending on interest years through the past 4 decades.

We will only be looking at a $2,000 monthly payments going towards interest and principal, considering the most common scenario: a 20% downpayment and a conventional 30 years fix mortgage. (you can run your own numbers on mortgage simulators such as Bay Equity's).


YEAR 1981 - Interest rate: 16.64% - Home price you could afford for $2,000/month: $154,000

In 1981, when interest rates were at a record high of 16.64%, a $2,000/month mortgage payment would get you a $154,000 house.


YEAR 1991 -  Interest rate: 9.25% - Home price you could afford for $2,000/month: $261,000

10 years later, in 1991, a $2,000 monthly payment would roughly get you a $261,000 house.


Year 2001 - Interest rate: 6.97% - Home price you could afford for $2,000/month: $324,000

The interest rate stayed in the 6% range for almost a decade. In 2011, they were on average 6.97%. Back then, a $2,000 monthly payment would have gotten you a $324,000 house.


Year 2011 - Interest rate: 4.45% - Home price you could afford for $2,000/month: $426,000

You know the drill... In 2011, we entered the era of sub-5% interest rates. the average interest rate for year 2011 was 4.45% and a $2,000 monthly mortgage payment would have gotten you a $426,000 house.


TODAY April 21st - 3.31% - Home price you could afford for $2,000/month: $490,000

Today April 21st 2020, the average interest rate (source Freddie Mac) is 3.31% on a conventional 20 years fixed rate mortgage. A $2,000 today gets you a $490,000 house.


So for the same monthly payment, you were getting a house for $154,000 dollars in 1981, and today that same money would get you a $490,000 house!!! Interest rates are a big deal when it comes to buying or selling a home.



THE UPSIDE OF LOW INTEREST RATES FOR HOMEOWNERS

You beat the bank. The interest rate is what the bank charges to lend you money. Basically, your $2,000 monthly payment splits into 2 parts: what goes towards paying interests and what goes towards the principal- the equity you have in your house. With low interest rates, more of your $2,000 goes towards equity, less goes to the bank. When you sell you house, you'll sell it for a higher price and will end up with more profit in a low interest rate scenario than in a high interest rate scenario.


THE DOWNSIDE FOR HOMEOWNERS

Here is the caveat: for the same monthly payment, you can afford a $490,000 house today vs a $154,000 house in 1981, but the downpayment is still 20% of the home purchase price. Therefore the downpayment on the $490,000 house is $98,000, when it is only $30,800 for the $154,000 house... The median income in the US in 1981 was $22,390 (source: Census bureau), so the $30,800 downpayment was roughly 140% of the yearly median income. In 2018, the median income in the US was $61,423, so a $98,000 downpayment is 160% on the median yearly income. Putting together the 20% downpayment is harder for buyers today than it was in 1981.


IN CONCLUSION: Don't get discouraged by the price of homes! Instead, try to focus on the monthly payment. If you look at it historically, and factor in interest rates, a home today is actually not harder to afford than it has been in the past. The downpayment may be a little harder to put together, but the monthly payment should be easier to make. 

This is the bottomline: you should buy your home when you can afford the monthly payment without putting unnecessary stress on your finances, and benefit from the appreciation over the long run. The low interest rate we have today will make it easier on your finances, even though prices of homes are higher than they were in the past.


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