Understanding Interest Rates
No, the bank isn’t giving out presents of tens and twenties this year. We’re looking at the cost of lending—specifically, interest rates. Free money in this sense would mean that the bank was lending money at 0% interest (i.e., no cost for the money borrowed). Is that what the banks are doing? Almost.
Okay, this one’s easy. If you’ve been thinking of buying lately, do it now. Interest rates are LOW; you’ve heard it, but how does that translate to real dollars for your monthly budget? Lets take a look at two scenarios:
We’ll keep the numbers simple. Two buyers each purchase a home for $100,000. Each puts down 20%, each pays $1,500 in annual property tax, and each pays $800 per year in homeowner’s insurance (of course, I’m not saying that these will be your numbers, but these are not atypical and will illustrate the point nicely). The difference between our two buyers is that buyer A bought his home five years ago and locked his rate in at 6.5%, a decent rate at the time, and buyer B bought her home last month, locking in at 3.5%. Well, if that’s the only difference, that doesn’t seem so bad. After all, what’s a measly 3%?
In fact, buyer A’s 6.5% translates to $697.32 per month over 30 years, whereas buyer B’s 3.5% is only costing her $550.90 each month—a difference of $146.42 a month. By the end of the term, buyer A will pay a total of $251,035.97, while buyer B will have to deliver only $198,324.19—a difference of $52,711.78. Buyer A ends up paying for over half a house more on the original sale price. And that’s on just a $100,000 purchase.
If we take a quick glance at a $200,000 home, with 20% down, $2,200 in annual taxes, $1,200 in insurance: Buyer A pays $1,294.64 per month and $466,072.00 by the end of the term; buyer B pays $1,001.80 per month and $360,648.38 total. Here, the differences are $292.84 per month and $105,423.62 by the end of the term… all over a measly 3%.
The moral of the story: Buy when the rates are low. A few measly points can make a big difference. Remember, that extra $150-$300 per month means an extra $300 this month… then, an extra $300 next month… then, an extra $300 the month after that… and so on, for the next 360 months.
And, oh, by the way, in case I forgot to mention it, rates are low now!