House Purchase Price Or Interest Rate: Which Is More Important?
As you go through the process of buying a house, you’ll come to realize that there are a variety of different factors that make up a given home’s level of affordability; it’s not just asking price, but also interest rate, taxes, cost to maintain the home and any other expenses associated with purchasing and living in the house.
While a home might be within your price range at first glance, these additional factors could actually push it out of the range of what’s affordable for you. This is especially true when it comes to your mortgage interest rate.
How exactly do home prices and mortgage rates interact, and is one of these factors more influential than the other? Let’s take a look at what home buyers should know.
What Do House Prices And Interest Rates Impact?
How much your home costs and the interest rate on the loan you used to pay for it both play a vital role in determining how much money you’ll spend on your home for as long as you live there – or at least until you’re done paying off your mortgage.
Most home buyers who use a mortgage loan to finance their purchase will need to put down a certain percentage of the sale price.
The standard is 20% down if you’re looking to avoid private mortgage insurance; however, the median down payment for U.S. buyers is 12%, according to the National Association of REALTORS®. On a conventional loan, it’s possible to go as low as 3%.
When considering how much home you can afford, it’s important to think about how much cash you have available to put down. If you put 12% down on a home that costs $200,000, you’ll need $24,000 to close on the home. If that house costs $250,000, you’ll need $30,000.
Both the price of the home and the rate on your mortgage will affect the size of your monthly mortgage payments.
Excluding taxes and insurance, your monthly mortgage payment is made up of two basic elements: principal and interest. Principal is the initial amount you borrowed, and interest is the amount you’re charged for borrowing that money.
It might seem obvious how the price of a home will impact the amount you pay each month, but you may not realize how much your mortgage interest rate can impact this as well.
Say you get a 30-year fixed-rate mortgage for $200,000 with an interest rate of 4%. Your monthly payment will be about $955. Contrast this with a $200,000 loan at 3.5%, with which you’ll have a monthly payment of $898. That’s a $57 difference each month.
Over 30 years, you’ll have paid your lender an additional $143,739 in interest on the 4% loan, and only $123,312 on the 3.5% loan.
Advantages Of Lower House Prices
Most hopeful home buyers dream of low prices – but what if that means taking on a higher interest rate? Which is preferable?
The immediate advantage of buying a home on the lower end of your price range is that you won’t need to bring as much cash to the table for your down payment.
If homes are more affordable because interest rates are high, buying a lower-priced home could work to your advantage in the long run if you think rates will eventually go down. Once mortgage rates drop, you may have the option to refinance into a new loan at the lower rate.
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Advantages Of Lower Interest Rates
Of course, having a low interest rate right out of the gate is likely going to be better for you than having to wait for rates to drop and then go through the refinance process. But is a lower interest rate worth a higher price tag?
In addition to lowering the amount of money you’ll pay to borrow the mortgage, low interest rates can give a small boost to your buying power, since a smaller portion of your monthly payment will put toward interest. This can mean being able to afford a little bit more house than you might in a higher rate environment.
House Price Vs. Interest Rate: Example Scenario
Is there any correlation between mortgage interest rates and home prices? If one goes up, does the other go down?
Low interest rates can increase demand for homes, while high interest rates can slow demand. When demand for homes go up, prices tend to follow suit.
However, there isn’t always a perfect correlation. In practice, there are many different factors that affect home prices and mortgage rates, including local market conditions and larger economic trends.
Which environment is better for home buyers? Consider the following example.
When Janet originally bought her house, it was worth $250,000. She made a 10% down payment, so she paid $25,000 out of pocket and financed the remaining $225,000 at an interest rate of 6%. She pays around $1,349 each month for her mortgage. If she were to keep her house for the entire duration of her 30-year mortgage, she’d pay $260,363 in interest.
Janet has decided, however, that now is the time to sell her home. Because home values have increased since she purchased her home, her buyer, Joe, plans to purchase the home for $300,000. Joe also decides to put down a 10% down payment, meaning he’ll pay $30,000 in cash at the closing table and will take out a $270,000 mortgage to pay the rest. Joe’s mortgage lender approves him for a 4% interest rate.
Despite paying more for the house than Janet, Joe’s monthly payment will be $1,289, and he’ll only pay $194,048 in interest over the life of the loan, thanks to his lower interest rate.
As we can see, interest rates can make a huge difference in a given home’s affordability. However, that doesn’t mean that you should sit around waiting for rates to go down before you buying a house.
It’s also possible for a lower-priced house in a high rate environment to be more affordable than a higher-priced house in a low rate environment; it just depends on how the math shakes out.
Can There Be Low Prices And Low Rates At The Same Time?
It’s possible for rates and prices to go down simultaneously – this happened during the Great Recession and for a short time after while the economy began to recover.
Simultaneous low rates and low home prices can be indicative of a struggling economy. During an economic downturn, home prices may go down and the Federal Reserve might decide to lower interest rates to stimulate economic growth. This can be an ideal environment for a hopeful home buyer, but if you’re struggling with unemployment due to a down economy, you probably won’t be able to take advantage of it.
Additionally, it’s hard to say whether you’ll encounter low prices and low rates at the same time, regardless of what the larger economy is doing, because home prices are so dependent on where you plan to live and what the housing market looks like in that area, including whether you’re in a buyer’s market or a seller’s market.
In general, this type of environment is probably not something you should hold out for, as you could end up waiting a long time.
How Long Should You Wait For Either To Drop?
Predicting which way the real estate market will move is tough even for the experts. While it might be tempting to wait for home prices to go down or the Fed to announce a rate drop, there’s no guarantee that your efforts will pay off.
If you aren’t in a rush to buy a home, you can always take a “wait and see” approach, but keep in mind that while prices or rates could drop, they could also stay the same or even go up.
Other Factors To Consider
It’s important to take a holistic look at what costs you’ll incur when you buy a house. Here are some other things that can factor into how much your home will cost overall.
If you’re moving into a neighborhood that’s part of a homeowners association, you should find out how much the association’s fees are. HOA fees can quickly push an otherwise-affordable home out of your price range, potentially adding hundreds of dollars to your monthly housing costs.
HOA fees are often around $200 – $300 per month, though they could be much less or much more depending on the community and its offerings.
Local Market Patterns
Home prices vary a lot from state to state, city to city, even neighborhood-to-neighborhood.
Local market trends can significantly impact how much homes sell for in a given area. In one city, a hot market might mean high prices and frequent bidding wars, while the next city over might see homes sit on the market for months before selling below asking price.
Taxes And Insurance
Along with principal and interest, these two factors make up the entirety of your monthly mortgage payment. You may see this referred to as PITI – principal, interest, taxes and insurance.
“Taxes” refer to your property taxes, which will vary depending on where you live. “Insurance” is what you pay toward your homeowners insurance premium. It may also include your mortgage insurance, if required.
All houses will cost money to maintain, though some houses will cost more than others. If you purchase an older home in need of some TLC, for example, you’ll likely end up spending more money on maintenance and repairs than if you purchased a newer home in better condition.
The Bottom Line
Ultimately, the best time to buy a house is when you feel you’re ready to do so.
Though there are benefits to both low rate and low price environments, it’s hard to time the market to your advantage. Doing so could potentially mean buying before you’re ready or waiting too long and missing out on a great opportunity.
Keep an eye on rates and prices, but also work on readying your finances for homeownership: saving for a down payment, building up your credit score and paying down any debt you owe.
Check out more home buying articles in our Learning Center.