Do interest rates really matter? Can 1%- 2% really make a difference?
After the real estate crash of 2007, home interest rates started falling, and have remained low for years. How low? I’m in my 30’s, so I have no reference point of buying houses when they were really high. But, I have clients who tell me they bought houses between 12-15%! Can you imagine? Besides 2012-13, rates haven’t been lower in over 40 years. When I first started buying real estate in 2005, I got around 6% for my first loan, and they’re lower now!
There’s been so much focus in the news on WHEN interest rates go up. However, they are still low. It’s possible we’ve gotten used to them being low, and don’t really know how good we’ve had it. So, let’s delve into why the interest rate on a mortgage actually matters.
“Interest rates matter because you can buy a lot more house for less monthly payment when the rates are low,”said Ross Peterson, Vice-President of Frandsen Bank & Trust, Cloquet
Peterson is confident interest rates will remain low for some time. At Frandsen, I recently was quoted 3.125% for a 15-year mortgage or 4% for a 30-year mortgage.* So, let’s look at what the house payment would be, and how much interest would be paid on these mortgages. For our example, we will use a 3.125% 15-year mortgage and a 4% 30-year mortgage for a person buying a $200,000 house, with 20% down. We will not be adding taxes or insurance into this equation. Then, let’s add a point to those two interest rates to see the difference we’d pay in interest, if the rates were just 1% higher.
15-Year Mortgage, 3.125% = Monthly payment: $1,114.57
Total Interest Paid Over Life of Loan = $40,624
30-Year Mortgage, 4% = Monthly payment: $763.86
Total Interest Paid at Over Life of Loan = $114,993
If you extend the mortgage from 15 years (Interest rate 3.125%) to 30 years (Interest rate 4%) , you will pay an additional $74,369. Ouch!!
Now, let’s look at the cost if interest rates were hypothetically 1% higher, to see if interest rates matter.
15-Year Mortgage, 4.125% = Monthly payment: $1,193.55
Total Interest Paid Over Life of Loan = $54,839
30-Year Mortgage, 5% = Monthly payment: $858.91
Total Interest Paid Over Life of Loan = $149,211
Analysis: You can see the difference in how much of a house payment is incurred with each additional 1% that’s added.
House payment for the following loans:
15 Year 3.125% Loan: $1,114.57
15 Year 4.125% Loan:$1,193.55
15 Year 5.125% Loan: $1,275.71 (added in for effect)
30 Year 4% Loan: $763.86
30 Year 5% Loan: $858.91
30 Year 6% Loan: $959.28 (added in for effect)
Difference in amount of interest paid:
Difference in interest paid between a 15-year 4.125% mortgage, and a 15-year 3.125% mortgage: $14,215
Difference in interest paid between 30-year 5% mortgage, and a 30-year 4% mortgage: $34,218
We are only looking at 1% here, but could you find something to do with an extra $14,000 to $34,000? I hope this sheds light on the value of interest rates, and how much additional cost they can add over the life of a loan. The takeaway? If you will be using financing for you next home, now’s a great time to buy!
*It should be noted that these rates are the best secondary market rates, and credit is taken into consideration in order to qualify. Also, rates fluctuate frequently, so be sure to check with your bank on their current rate.