For potential homebuyers, and for folks who already have mortgages, the importance of the latest decline in interest rates cannot be overstated.
The largely unexpected drop in long-term interest rates during the past year means that, in broad terms, homes have become more affordable even as selling prices have increased.
Consider that the median selling price of a home in the Charleston area increased by nearly 5 percent during 2014, rising to $215,000. Despite the more than $10,000 price increase, it would cost less to buy a midpriced home today than a year ago, assuming most of the purchase would be financed with a mortgage.
Rates have fallen so much that people can borrow more, and yet pay less.
For example, borrowing $175,000 this month would cost less than borrowing $165,000 a year ago. The monthly payments and the total cost of the loan would be lower, and the borrower would build up home equity more quickly.
Someone who borrowed $165,000 in January 2014 would have had a monthly mortgage payment of $829. Someone who borrows $175,000 — $10,000 more — this month, would have a monthly mortgage payment of $802. That’s based upon a 30-year fixed-rate loan at the average interest rates reported by Freddie Mac — an average of 4.43 percent in January 2014 vs. 3.66 percent in the latest weekly survey for January 2015.
Now, saving $27 a month on the mortgage payment for a midpriced home may not sound like a big deal, but the impact on wealth-building home equity is even larger. Home equity is the value of the property minus the mortgage balance — it’s the amount of money you get to keep if you sell, minus real estate commissions and other costs.
In my example, the person who borrowed $175,000 for 30 years at today’s interest rates would pay off $17,282 of the loan balance by the end of the fifth year, versus $14,476 for the person who borrowed $165,000 at last January’s rates. The difference in home equity — $2,806 — is in addition to the nearly $1,600 in savings during that period from lower monthly mortgage payments.
Over the life of the 30-year loans in my example, the person who borrowed $10,000 more would pay $9,951 less.
The drop in interest rates has also made it more affordable to consider a 15-year mortgage rather than a 30-year. A 15-year loan saves even more money on interest costs and builds equity very rapidly.
Mortgage interest rates aren’t the lowest they’ve ever been, but they’re close, and falling as I write this. The official national average on a 30-year loan is 3.66 percent, but I’ve seen fixed 30-year rates this week as low as 3.375 percent, roughly matching the all-time low last seen at the end of 2012.
Not surprisingly, people have been refinancing mortgages at a brisk pace. The Mortgage Bankers Association reported a 66 percent jump in applications to refinance earlier this month.
If you have a mortgage and missed the chance to refinance in late 2012 or early 2013, now you have another great opportunity. And real estate prices have gone up — a boon to those who previously had too little equity to refinance.
Those who are considering refinancing, or buying, should shop around for the best deal and consider not only the interest rate, but the closing costs a lender would charge. Those costs can vary by thousands of dollars.
Also, don’t overlook the cost of private mortgage insurance, which lenders typically require for a home loan when the downpayment is less than 20 percent. The PMI charges can be substantial, and with FHA loans, the borrower has to pay those charges for the life of the loan.
For homeowners who have enough equity, refinancing can be one way of escaping PMI charges. A borrower who doesn’t have enough equity to drop PMI under their existing loan, based on the purchase price of the home, might have enough equity to avoid PMI if they refinance with a current appraisal.
How long will these low rates last? Can they go even lower? Who knows, but we’re close to record lows right now.
I thought the mortgage rates we saw at the end of 2012 would never be seen again.