Interest Rates and Houses

For somebody that worked in finance for 25 years I never showed a tremoundous interest in interest rates, no pun intended.  Obviously they were there and you did the analysis and came up with an all-in finance cost and said, here, this is what this stupid project of yours is going to cost.  Take it or leave it.  Well, I wasn't quite that cavalier but close.  I was always more interested in how the business worked and how much money could be generated by becoming more productive. 

But when it comes to housing, interest rates are pretty important.  Plus I am always amazed at the impact of an interest rate change on the monthly payment.  I mean the difference between 6% and 6.1% isn't all that huge but the difference between, say 6% and 9% is.  How much you say?  Well, first, the question should be "When have rates ever been near 9%?"  Certainly not in your lifetime.  Wrong.  If you are in your mid-20's mortgage rates have been as high as 15%.  Early in your lifetime but in your lifetime, nonetheless. 

So what is the impact of an interest rate change on your monthly payment.  Let's assume a $150,000 mortgage at 6%.  Not counting insurance or property tax escrow or points, your mortgage payment on a 30 year loan is $899 a month.

If somehow the rate goes to 9% your payment is $1,206.  Not a killer, we hope, but you still have to cough up an incremental $307 a month.  I doubt if your pay goes up automatically like that so probably a tough nut to swallow. 

Just for fun, let's do 15%.  Now you are paying $1,897.  Close to a $1,000 more a month than a mortgage at 6%. 

Not going to happen, you say.  Sorry, it already is.  People that, for some reason, took out adjustable rate mortgages are seeing their payments double and more.  Which is why you see a lot of homes, mostly new homes, foreclosed on recently.  People get a sucker rate and then it changes and so do they--they are homeless. 

So never do an adjustable rate mortgage, right?  No, I did one once.  Everybody said I was nuts but I did it and I made money because fixed rates were 14% and adjustables were 10%.  I figured that the traditional fixed rate of 9% was much lower than 14% so took the risk on 10%.  This is when people were saying oil was going to $100 a barrel and gold to a $1,000 an ounce.  Kind of like now in some circles. 

The rule of interest rate management is Are Current Rates Below The Historical Average?  If so, fix the rate.  If rates are considerably above the historical average, go adjustable.  Finance is easy.

Comments

[Andrew N]

I just got my first mortgage a month ago; I was "greedy" and gone with the 5.05% ARM instead of the 4.9% fixed, seemed like a good idea especially since I expect rates to rise a little then fall again in early 2008 but now I'm not sure.. time will tell!

[DrHousingBubble]

Great site Uncle Bill!

You hit a key point in regards to mortgage rates. A jump from 3% to 6% will make a larger monthly dent than say a jump from 12% to 15%.

Many ARMs tease you with a low rate, sometimes 1.5% to 3% only to jump in two-years.