Oh Horrors, Rates Have Risen!


The recent interest rate increase has caused more hand-wringing and dismay than anything since the failed appearance of the Comet Kohoutek. Oh, shudder, whatever are we going to do since rates zoomed to 5.67 on July 17th? That, says Freddie Mac, is with .5 points.

Let's be honest. If someone said a fixed-rate mortgage was available at 5.7 percent a year ago many borrowers would have carried a sack of concrete blocks barefoot over fiery coals to get such financing. Rates were nearly a full point higher at the time according to HSH Associates, the independent and authoritative financial publisher.

Are we really so sensitive to rate changes? While 5.7 is more than 5.2, is it truly a big deal?

Yes and no.

Suppose you borrow $300,000 at 5.7 percent over 30 years. Your monthly cost for principal and interest is $1,742.20. At 5.2 percent, the cost is $1,647.33, That's a difference of $94.67 a month or $1,136.04 a year.

The argument here is not that higher rates are desirable or delightful, nor should anyone be elated to spend an extra $1,136.04 yearly. Instead, the idea is this:


Money is a commodity.

Rates rise and fall continually.

You want the lowest possible rate when borrowing.

If rates drop, there may be opportunities to refinance with little or no cash required at closing. (Note: There is no such thing as a "no cost" or "zero cost" loan -- otherwise it would be interest-free....)

Equally important, interest rates must be seen in context.
Real estate, like money, is a commodity so prices rise and fall. Go back to that $300,000 loan. Imagine that it was used to purchase a home with 5 percent down, a property priced at $315,000. For purposes of example, let's say all closing costs were covered by the seller.

So now you have a $315,000 property and a mortgage at 5.7 percent. Question: How much must the value of the property increase to recover that $1,136?

Let's see, if the property value grows 1 percent you would be ahead by $3,150 -- that's nearly three times $1,136. If the property value increased by the rate of inflation, say 2.1 percent, the increase seen during the past year according to the Bureau of Labor Statistics, then the value of the home would rise by $6,615 -- almost six times the additional interest cost.

Or, imagine you need to refinance. You have a 7 percent loan. If you refinance a $300,000 balance your monthly cost will go from $1,995 at 7 percent to $1,741 at 5.7 percent and $1,647 at 5.2 percent.

No doubt you would rather refinance at 5.2 percent. But 5.7 percent is not hideous -- you'd save $254 a month or $3,048 yearly.

I am aware that the additional mortgage interest is generally deductible for tax purposes, but real estate should be bought because it's where you want to live and you think the value will increase, not solely for tax deductions. Combine a big tax write-off with a property that declines in value and you still have a poor deal.

Since real estate is a commodity, it's possible that values can fall. This has happened in a number of local markets over the years, so to say it can't happen is imprudent at best.

But, generally, real estate has appreciated over time, often at a rate which exceeds inflation, thereby creating real buying power and wealth for owners.

Should prospective buyers be concerned about rising rates? Certainly. Buyers and owners should be constantly watchful, always looking for opportunities to finance and refinance.

Is now a time to be out of the market? In terms of interest rates this is a great time to buy and refinance -- not the best time ever in the history of the universe, but certainly not cause to sit on the sidelines.

The better question is whether you expect real estate values in your community to increase as a result of an expanding population, a growing job base, inflation and other factors. Do you believe the local economy over the long run will support higher prices? Do you believe mortgage rates will stay within the realm of reason? If yes, then a marginally-higher rate of interest is simply a cost of getting into the game.