It’s a good time to buy a home when you are able to afford the mortgage – along with all your other expenses – and buying is cheaper than renting.
That’s generally held as a universal truth designed to take speculation out of what’s likely to be your most expensive acquisition ever. It doesn’t matter which way home prices are swinging or where interest rates are going, buying a home is a very personal financial decision, or so the advice goes.
However, today’s record-breaking mortgage interest rates are giving cause to pause on that good-time-to-buy axiom.
Home prices are near rock bottom, but some market conditions are pointing to even lower interest rates and that could make a big difference in your ability to afford a mortgage.
The Federal Reserve, concerned the economy hasn’t built up enough steam to fuel growth, is going to keep its benchmark rates stable until 2014.
“To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee expects to maintain a highly accommodative stance for monetary policy. In particular, the Committee …anticipates that economic conditions – including low rates of resource utilization and a subdued outlook for inflation over the medium run – are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014,” the Fed said in it’s Jan. 25 monetary policy release.
The benchmark rates include the Federal Discount Rate, which now stands at 0.75 percent. The discount rate is the rate at which eligible financial institutions borrow funds from a Federal Reserve bank.
Also, the Federal Funds Rate, at zero to 0.25 percent, is the interest rate at which banks and other depository institutions lend money, generally overnight, to each other.
While benchmark rates have a limited impact on fixed rate mortgages (FRM) they do impact shorter term rates including those attached to home equity lines of credit and adjustable rate mortgages (ARMs).
How low the Fed’s action alone will push mortgage rates is anybody’s guess, but take a look at what lower rates would mean.
- A $250,000 mortgage financed at today’s readily available 4 percent rate would cost about $1,194 a month for a principal and interest payment. Cut the rate to 3 percent and the payment falls to $1,054. At 2 percent that $250,000 mortgage would cost only $924 a month.
- From 4 percent to 2 percent the savings is $270 a month.
- A larger mortgage, shows a more significant drop in the monthly payment amount.
- A $500,000 mortgage financed at 4 percent, costs about $2,387 a month. At 3 percent, the payment is $2,108 and at 2 percent, only $1,848.
- From 4 percent to 2 percent on the half million dollar mortgage, the savings is $539 – a nice chunk of change.
But 2 percent?
Some 15-year FRMs and some ARMs are already below 3 percent. Along with federal benchmark rates remaining low, if the economy doesn’t find traction and if unemployment keeps a lid on mortgage demand, rates could get lower.
Back in 2009, 2 percent was considered an optimal rate to help get a Making Home Affordable modification’s mortgage payment down to 31 percent of a homeowner’s household income. A third of household income is generally accepted as the recommended level of spending for affordable housing.
“To reach the target affordability level of 31 percent, interest payments will first be reduced down to as low as 2 percent. If, at that rate, the debt to income level is still over 31 percent, lenders then extend the term or amortization period up to 40 years, and finally forbear principal at no interest, until the payment is reduced to the 31 percent target,’ according to an early U.S. Treasury rendition of the program in, “Making Home Affordable Updated Detailed Program Description.
Should you hold out for a rate as low as 2 percent?
Sure, if at that level it means you are able to afford the mortgage – along with all your other expenses – and buying is cheaper than renting.
And, if you can live with the risk that rates will actually fall that low and are prepared to suffer the consequences if they don’t.