Does it matter if you have a $300k mortgage at 5.5% or a $270k mortgage at 6.5%? In the the last few years we’ve seen housing prices skyrocket while mortgage interest rates have remained extremely low. Now that rates are increasing, we’re probably going to see housing prices slipping a little as to keep the relative monthly cost at about the same levels (plus a bit of appreciation) and thus the total payout at the same levels (if you keep the home until you fully pay off the mortgage). Recall that the payment has a principal and an interest component so with interest rates rising, a greater portion of the total payout will shift from the interest column to the principal column. One would anticipate housing prices slip a little, or not rise as quickly, as interest rates rise because buyers don’t have any more money when the rates rise and thus the total monthly price must remain the same.
Assuming a 30 year fixed interest rate mortgage loan:
|Mortgage Amount||Interest Rate||Monthly Payment||Total Interest||Total Payments|
Now one would argue that part of that interest will be returned to you each year because of the mortgage interest deduction so to make that comparison (and to make it simplistically) we’ll simply take the difference in interest payments, divide by 4 (assuming a 25% marginal tax rate), and find that the difference is about $7800 over 30 years between the 6.5% and the 5.5% interest rate rows. Granted, the rebate should be heavily skewed towards the front of the loan but it’s a mere $7800 on a six figure loan (2.8%). When you compare the difference between the 10% and 5.5% loan, it’s a more significant $26,689.94 (13.7%).
However, one thing this does illustrate is that the price of the house should fall as interest rates rise because the monthly payment should remain the same for one house. As rates approach 6.5%, one would anticipate that a $300,000 house would sell for only $270,000 and that you shouldn’t worry when it does. This doesn’t bode well for people who are flipping homes and could be why existing home sales have slowed down?
Caveats: This simple math ignores or simplifies a lot of things like how the mortgage is amortized, the type of mortgage (30-year fixed), transaction costs, inflation, etc. I think it’s conceptually right though and if I’m wrong, I’d really like to hear about it.