In A Rising Market Interest Rates Are More Important Than Purchase Price

MEMORANDUM

FROM:     Dave Taormino, Sr. Vice President

DATE:      February 5, 2013

RE:           In a Rising real estate market interest rates are more important than purchase price.

______________________________________________________________________________________________________

Home prices are rising in nearly all of California. Davis and Woodland are no exceptions. Low inventories are contributing to price increases locally, but that is not the exclusive source. Historically job growth and new family formations generate demand and increased home prices. Today statewide job growth and a balanced state budget are contributors to home price escalation and expectations for more increases.

Low inventories appear to be primarily a result of potential sellers holding off selling expecting a better price in the future. That works ONLY if they are not purchasing a replacement home; otherwise their potential gain is offset by a higher price on their replacement home.

Typically a seller “buys” up approximately 30%-50% more in home value than their current home. The next home also comes with a larger mortgage as well. 

By way of example:

Value of Current Home                 $250,000             Replacement Home Cost $350,000      

Existing Mortgage/Costs of Sale ($150,000)             Transfer of Net Equity    ($100,000)    

Net Equity to Reinvest                  $100,000             New Mortgage                 $250,000

Here’s the conundrum of waiting to sell. First, applying for example purposes only an 8% per annum price increase to the existing home, generates $20,000 more value next year, but the same 8% percent increase also applies to the replacement home in my example raising its value an additional $28,000 and adding more dollars to the replacement mortgage by $8,000.

Second, most sellers have taken advantage of the historic low interest rates through refinancing. These amazing rates cannot be sustained much longer. While the Federal Reserve has left a lot of “wiggle room” in its promise to hold down rates, we recognize interest rate increases only after they occur when it is too late. Experience indicates that it takes three or four months for sellers to decide to sell and purchase a replacement home before a new loan rate is secured. Timing interest rates at the lowest point is similar to timing the stock market, both amateurs and experts guess incorrectly.

In my earlier example, here are the monthly differences in principal and interest on the same $375,000 mortgage for a replacement home.

Interest Rate

Monthly Principal and   Interest

Yearly

Last time this Interest Rate was Common.

Cost difference over 10 years

3.5%

$1,122

$13,460

1950

0

4.0%

$1,193

$14,316

1952

$8,600

4.5%

$1,266

$15,200

1953

$17,400

5.0%

$1,342

$16,100

1960

$26,400

5.5%

$1,420

$17,000

1964

$35,400

6.0%

$1,500

$18,000

1965

$45,400

Same house, same purchase price, same mortgage, but look at the 10 year cost of occupancy between today’s 3.5% rate and “tomorrow’s” 6% rate. In my example any of these interest rates would be considered historically low. The interest rate is the fundamental cost of occupancy and what determines our ability to comfortably afford a home.

My advice for potential Sellers: Take advantage of the current extraordinary low rates NOW. Price appreciation happens across the board. You will be very glad in a year or so, possibly sooner, that you did. Make selling and repurchasing now a smart business decision.

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