The Expert Podcast

So you may be wondering what is the bigger thing to worry about in terms of a future mortgage payment: is it that the home values are going to go up or the mortgage rates going to go up? A lot of home buyers are thinking about the decision of buying or not buying based on what they're imagining is going to happen for home values or mortgage rates, and we're going to take a close look and see which one affects your mortgage payment more. Now, we're not talking about that after you've purchased a house your payments are going to go up, because if you purchase a house and you have a fixed mortgage—fixed rate mortgage—your mortgage payment stays the same. Your loan amount doesn't go up because you already bought the house for a certain amount of money, and your interest rate doesn't change. Your payment is going to be a standard amount throughout the length of the loan. So we're talking about considering a purchase in the future, making decisions based on imagining the rates kind of go up or where the prices are going to go up.

Popular wisdom says the prices are going to go up and rates might go up too, but which is going to have a higher effect? So we're going to look at a loan amount of $200,000 on a 30-year fixed mortgage. Right now prevailing rates are just under 4%, so we're going to plug in 3.8%. That gives you a monthly payment of $932 for a $200,000 house. And as a side note, we've talked before about how it's a good idea to buy a cheap little $200,000 house if you're renting.

Even if that house isn't your dream home or ideally what you want, or maybe not in the ideal location you want, because first of all, you're going to save money on rent. You're probably paying more than this in rent even if you add in your property tax and insurance, which might add three or four hundred dollars a month to your monthly payment. You're still going to be under $1,500, and in most cases, you're going to be spending higher than that for any kind of two-bedroom or three-bedroom apartment or rental home anywhere in the country.

So by purchasing even a cheap little house, not only are you locking in a monthly payment for your housing that's lower than what you have now, your money's going towards a mortgage and not towards a landlord. It's going towards an appreciating asset, not just throwing it as rent, right? So $932—that's your base payment. So what would happen if the price of a house went up? Let's put it at $240,000. That's about a 20% increase in the value of the house from $200,000 to $240,000. Well, your mortgage payment went up about $300.

What happens if your interest rates go up in the future? They're talking maybe the interest rates might go up to 5%. Well, it goes up about $100–$150. So the price is going to affect your mortgage a lot more than the rate. And $240,000 would be a pretty big jump, but so would 5%. In either case, these changes in market factors are going to put pressure on housing costs. If you've already locked in your house purchase, even if the rate is 5%, you know you have a $200,000 mortgage, you're still at about $1,000.

That amount is not going to change. Unlike rent, your landlord can next year decide they want to jack up your rent $400 a month. Your mortgage is not going to go up. Your interest rate is not going to go up on a fixed rate mortgage, which is how almost all mortgages are done now. So that's a good comparison of what affects your monthly payment more: interest rate or dollar amount. Let's take a look at a $200,000 mortgage: how much do you have to change it for each percentage point of rate? So let's go from

5% to 4% and see what it changes. 5% to 4% changes about $120. So let's go back to 5%. Let's see what we have to do to this to get it down to $955. Let's try $190,000—not quite. Let's go down to $170,000—too much. Let's go to $180,000. Let's go to $177,000—pretty close. So a 1% change in the mortgage rate equals about $22,000 or $23,000 in price. Think about that.

The other consideration is there is a way to lower your interest rate. If your home goes up in value, you buy it for $200,000. That equity is locked in for you—that's never going to change. Your purchase price will always be $200,000. If in five years it's worth $250,000, your cost basis is $200,000. However, if the interest rate goes up from 5% to 6% to 7%, well, your mortgage payment's not going to go up to $1,300; it's still going to be locked in at 5%. However, what happens if interest rates go down, right? If interest rates go down, you can refinance—and you've heard about this—if interest rates go back down to, let's say, 3%, you can refinance your mortgage and drop your payment.

So a lot of times people think it's bad to buy when interest rates are high. It's actually good to buy when interest rates are high because it keeps the price low, which is a fixed amount. Once you pay the $200,000 for the house, that's a done deal. That $200,000 is paid. Your interest rate can change; it's up to you though—you don't have to change it if it goes higher. If it goes lower, you can refinance. So the mortgage is something you can replace; your purchase price, you can't.

So if interest rates are high, that doesn't mean that it's a bad time to buy. In fact, it might be a good time because it might keep the cost of your house a little bit lower than what it would be in a normal market. And then as long as you can afford your payment, let's say at 5%, your payment's going to be $1,074. Pay your payment, pay your payment. Five years from now, the rates drop down—boom! You can refinance to $850. If the interest rates go up some crazy amounts of 9%, everybody else that buys that house is going to be

paying $1,609 while you're paying $1,074. Your rate does not change if rates go up, but if they go down you can refinance and save a couple hundred. You can't do that on rent. If your rent goes up, too bad, your landlord's gonna charge you rent. So this is a good example of how price and rate are related and which one has more effect than another on purchasing a house.