If you have paid attention to what has happened to interest rates over the past 18-24 months, you would know that we are in a historically low interest rate environment. Albert Einstein once quoted that compounding interest should be the 8th wonder of the world, and rightly so, as many people just don™t grasp or fully appreciate the difference the overall change in an interest rate can make on a home purchase in terms of a buyer™s pocketbook.
If we look back to the 1st half of 2010, with the ramp up of activity due from the first time homebuyer credit, interest rates stood in the low 5% range for a 30-year fixed loan. Today, they are nearly a full point less, trending in the very low 4% range.
Does this sound like a lot? A 1% difference? Not really, especially to someone who doesn™t spend every day of their lives in a financially-related industry. But let™s take a closer look at the difference 1% can make with the following example:
Let™s take the median price for a newly built home, which is $222,000 as of July 2011, according to US census data. Let™s also say that you are first time home buyer and utilizing the popular FHA loan in order to finance your property “ this means you are able to finance the home with a low 30 year fixed rate loan and all you need to do is put down 3.5% – that™s about $7500. So all said, in this example, you are financing a total of about $215,000 in this real estate purchase transaction.
Now “ let™s say that this was last year when rates were 5% – first off, prices were slightly higher (as we have seen prices slide slightly from the aftermath of the boom in activity that the first time home buyer credit brought on) But that being said, a 30 year loan at 5% where you are financing $215,000 means your total interest paid over the life of the loan is $190,377.02 “ if you were do the same thing but at 4%, the total interest paid over the life of the loan is $145,471.52! One percent interest is equal to a 25% difference in the total interest paid by the borrower, a total of $45,000 saved because of one measly point.
Now something to take into account is that this is for the life of the loan, so this assumes that you will stay in this home and pay off the loan completely over the course of 30 years.
This does not represent your typical homeowner in America. Your typical buyer owns a home for about 5-7 years, or less, depending on where you live in the country. So, although 1% makes a huge difference over time, its beneficial effects to a typical homebuyer will be somewhat less because they aren™t around for the full 30 years to realize all the savings. However, the big banks have rigged the borrowing game. They know that most buyers only stay in a given home for a handful of years, so they work a loan payoff where the majority of the interest that you pay on a mortgage is paid for in the first 5 or 6 years in a loan, and then proportionally more of a monthly payment goes towards the principal owed as time goes on. This makes it so the banks make out as best as possible for every loan made (there™s a reason why all the tallest buildings in each city have a bank logo on it), but also, it makes it that much more significant for the interest rate that you can get because that will mean more savings (proportionally) to the borrower because you are paying mostly interest upfront, it ought to be the lowest rate possible.
I hope this is making sense, but if you have made it this far, you are probably eating what I am dishing out.
So why are interest rates so low right now anyways? You can attribute it to many reasons, but at the end of the day, this country cannot afford to have them any higher. Studies have shown that the housing industry is responsible for up to 30% of the consumer and consumption portion of the United States GDP. Because the housing market has been in the tank for the last couple years, interest rates respond accordingly to entice any would-be buyers into the market (as well as offering an opportunity for current homebuyers to refinance their current loan and lock in a lower interest rate.) In a hot market, you will see higher rates, and in a down market, just the opposite. Because we have not gotten the rebound that we would like to see, one of the tools that we have in the box to apply to the fledging housing market and the economy at larger is to have people™s interest rates lower. This effectively saves people money. Money that would otherwise go to a bank instead gets invested into the economy via a home purchase, home repairs or renovations, or expenditures unrelated to the home at all due to the increase in a person™s disposable income. This money saved pays for the jobs, services, and products that all flow directly or indirectly from housing into the general economy and we all benefit as a result from it.
But with all that said, we still find ourselves right in the middle of a market that has a lot of negativity, and rightly so because there is a seemingly incessant amount of bad news that is coming from the major media outlets. Every day you hear another crisis, or horror story, or country going bankrupt, or systemic financial problems with our own country “ and all this will just intensify as we get closer to the elections in 2012 “ but with all of this happening, I would advise against correlating this with the notion that buying a home is a bad idea. I would go so far to say that the best thing for people to do right now is to go about their lives, their goals and their dreams and do so without being affected or distracted or having to second guess your decisions and ambitions based on what is happening in the outside world today.
If you buy into the argument that inflation will be on the rise and that interest rates will inevitably increase to combat it, then it would be wise and would completely justify buying a home now to take advantage of the low interest rate as well as the low home value, because as inflation rises, it will increase the price of a œbasket of goods and services in general, and a home is included in that basket “ not only will the price of a loaf of bread go up but so will housing, irrespective of what the economy does.
For real estate in general, we are running out of it. Simply put, there is only one earth and there is an explosion of population. There are 6.5 billion people here today, and there will be 10 billion by the end of the century, and we all know about supply and demand. I know what I am writing is somewhat general and vague, but sometimes these basic tenants and comparisons need to be conveyed in order to illustrate a larger point. The best parts of earth, the best real estate out there, will only become more and more valuable. As time goes on, we will look back at this timeframe with depressed prices and incredibly low interest rates, and I personally know I will be wishing I bought more property at this time “ I am limited in overall financing because I am not made of money, just like everyone else “ but I am compelled by the fact that so many people are being effected by fear, and I can see that it is creating such a great opportunity for people out there looking for a great first time home, move-up home, or investment property, and the low interest rates represent the icing on the cake for this opportunity.
Real estate is not just a great buy now just because interest rates are low; it is a great buy now because so many people out there don™t believe it to be true. The market goes through peaks and valleys, booms and busts, and if you talk to real estate professionals who have been in the business long enough (for 20 or 30 years or more), they have seen booms and busts and know what they feel like and are wide-eyed with optimism right now (for the most part) for what the future holds and how overall real estate prices will fare over the next 5 years.
There have been about 15 market cycles over the past 7 decades, and throughout these cycles, the average boom lasts about 3 years and the average bust (or recession, or correction – whatever you want to call it) lasts about 1-2 years. Overall, through the course of time we have been growing but you get the point that this is the natural pace of which things have worked for several decades.
Well, when we take into account the most recent boom “ which lasted a full on 9 years, what does that entail for the correction that follows? I think we are living in the response (or aftermath) right now “ I think we are in a prolonged correction phase because the boom phase was just so prolific and prolonged. This correction has been a long lasting and difficult one, and because it tends to go on and on, many people make their decisions and live their lives based within this fear; and when extrapolated to the entire country, we can see why this is a catch-22 “ a vicious downward spiral, or a self-fulfilling prophecy “ that we are in a recession and it tends to prolong further because of the overall effect that being in a recession has on a typical consumer which only serves to cause the consumer to make decisions that only continue and/or deepen the recession further.
This is why I say go and œdo your dreams, do what you want to do and don™t let the media tell you it™s a bad time to travel, to purchase things (as long as you are doing it prudently) and live life “ on your terms. It™s good to be contrarian; Warren Buffet says œI am greedy when other people are fearful and fearful when other people are greedy. There is a lot of fear out there, but fortunately, I believe it is proportional to the amount of opportunity that exists in the market today.
No doubt challenges exist in the world, with our country, within our respective state(s) and even our own local municipalities, however there will always be challenges because that is life and life is not all flowers, hugs and sunshine. We learn and grow from our challenges, we evolve, and we enhance ourselves in the process and make a better tomorrow as a result. Point is, in order to take advantage and truly grow, one must lead the way, and show others what could be. Real estate investors and first time home buyers that are taking action today and signing on the dotted line will be tomorrow™s wealthy. After 5-6 years of living in a real estate correction we are bound for the rebound “ its on the horizon, and those who are taking action when everyone else won™t, and when many are too afraid or financially unable to, it will be the action-takers that will reap the biggest rewards when the general populace has decreed that our recession and correction is over and the œgood times are upon us once again.
When purchasing а home fоr thе first time, new home owners neеd а wаy tо finance this large аnd life-changing purchase.
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