By Ali Donoghue
Like it or not, if you need a mortgage to buy a condo, you need to understand interest rates. Your interest rate – together with the size of the the loan – determines the amount of monthly payments when you take out a mortgage on your home. So, for example, if you get a mortgage with a 4% rate, that’s how much you’ll be charged each year for the amount remaining on your loan. It’s the fee for the privilege of borrowing money.
Right now, interest rates are very low, hovering at around 4%, which favors buyers. Historically, however, rates have been much higher. And, Janet Yellen, the Chair of the Federal Reserve, has recently given strong indications that the rate will go up in the coming months. As a potential home buyer, this affects you directly: if the rate goes up, you’ll be able to buy less of a condo for the same monthly payment.
For example, if you qualify for a 30-year, $100,000 mortgage at 4%, with a monthly payment of $477, and the rate jumps to 5%, that same $477 monthly payment is only enough for a $89,000 mortgage. If the rate goes to 6%, you can only get a $79,500 mortgage for the same monthly payment.
Or, if you still need to get that $100,000 fixed 30-year mortgage in order to buy your dream condo, at 5% interest it will cost you $537 a month, or $60 more, and at 6% it is $600 or $123 more a month.
It’s a real bummer, even though you partially recover the extra monthly payment in the form of mortgage interest tax deduction.
But does that mean you should stop searching for your condo? Not necessarily. While rates are important, they shouldn’t be the sole driver of your decision. Here are some other things to consider:
• Can you pay cash? If you can purchase the home without taking out a loan, the interest rates don’t affect you. (And, to some extent, if you are able to put down a large amount, like over 50%, the interest rate won’t have such an outsized effect on your purchasing power.)
• What’s the rental market like? If the rental market is expensive and competitive, it may make sense to buy, even with higher rates. And, generally speaking, if you buy, your place will be nicer and larger than if you were to rent for the same monthly payment. (Though, of course, if you rent you don’t have to come up with a down payment.)
• How high is a higher rate? Even 5 or 6% is relatively low, historically speaking – while it may seem high in comparison to the past few years, we’re not talking about exorbitant rates. In ten years, it may still seem like a deal.
• What about appreciation (and depreciation)? If you’re planning on buying a condo as a starter home, you’re not going to stay for long enough to build significant equity by paying down principal. Whether the home turns into a savvy financial investment depends on the housing market. Do you expect the home (and neighborhood) to increase or decrease in value? That’s just as important.
• Did you know you can refinance? While there are fees associated with refinancing, if you buy at a high rate and several years later the rate goes down, you can refinance to take advantage of the lower rate. So, just because you buy at one rate, it doesn’t mean you’re stuck for thirty years.
In addition to financial reasons why you might still buy despite higher rates, there are also personal reasons, which are just as important.
• You value having control of where you live. Owning can be a powerful thing. You can do what you want to the walls, you have a stake in your neighborhood, and no one can evict you or raise your rent. For many buyers, that’s worth a lot.
• You’re ready to settle down. Especially if you’re in a stable long-term relationship, it can make sense to pool your resources and buy property, rather than search for a rental to suit your needs.
• Where you want to live doesn’t have good rental options. Not every area will have a robust rental market for the type of housing you want. For example, if you’re interested in a living in a modest single-family home, with a backyard and a garage, in many parts of the country you’re not likely to find many appetizing rental options. Depending on the cost, buying might make sense.
To sum up, interest rates are an important consideration when you’re looking to buy – but they’re only one part of the equation. If you’re personally ready to buy, your finances are in order and you understand the market, buying may be the right choice for you, even if rates do rise.
Ali Donoghue is a Redfin real estate agent in Chicago. She’s an expert negotiator who loves educating her clients about all aspects of the real estate process. In 2013, she was named a Top 1% Producer by the Chicago Association of Realtors. While she’s studied in London and speaks Italian, Donoghue is a lifelong Chicagoan who has enjoyed watching the Windy City’s neighborhoods transform over the years.