“The following is a great article that sheds some light on what the associated cost is of waiting to purchase a home if you think home prices will go down over the next while, versus the risk of being incorrect (or correct on a fractional degree) and interest rates going up. This is a question that I often receive from my clients, and for every client it is a very personal answer based on their risk profile/tolerance, their predictions of the housing market and their view on the pace that interest rates will increase. One thing is for sure, interest rates will need to increase eventually”. Roland Kym, November 11, 2010
If you are like many potential home buyers today, you are wondering whether home prices are going to decrease, by how much and when. You are also wondering whether instead, to buy now to take advantage of ultra-low mortgage rates.
Your choices lead to the consideration of weighing the benefits of low mortgage rates now versus waiting for possible decreases in home prices. In other words, will a low mortgage rate now benefit you more than a potential decrease in home prices – and how much would home prices need to decrease to offset you paying potentially higher mortgage rates. Not easy to predict, and not an easy decision, but I’ll try to help with some calculations.
First, to help you understand the increased interest costs when mortgage rates increase, here is a comparison between three mortgages of $350,000, assuming a 5 year fixed term, 35 year amortization and rate increases of one half percent for each calculation.
| Mortgage Amount | $350,000 | $350,000 | $350,000 |
| Amortization | 35 Years | 35 Years | 35 Years |
| Interest Rate | 3.75% | 4.25% | 4.75% |
| Interest Term | 5 Years | 5 Years | 5 Years |
| Rate Type | Fixed | Fixed | Fixed |
| Payment Frequency | Monthly | Monthly | Monthly |
| Payment Amount | 1491.70 | 1594.72 | 1700.82 |
| Term Interest Cost | $62,747.73 | $71,288.38 | $79,849.12 |
| Amortization Interest Cost | $276,509.67 | $319,774.07 | $364,341.76 |
Source: RBC mortgage calculator at www.rbcroyalbank.com.*
The bottom line here is that you will pay $17,101.39 more interest during the first 5 years of your mortgage alone if the mortgage rate is increased by one percent. Your overall payment per month is also $209.12 more.
This leads to a second calculation/consideration to help you decide whether to wait – and that is your purchasing power, which is based directly on the size of the mortgage that you qualify for. When mortgage rates increase, you qualify for a lower mortgage amount and thus a lower purchase price. To what extent could you be affected?
Let’s assume that you meet with a mortgage specialist today and after all of your financial information is considered, you qualify for a mortgage of $350,000. (As above, you have chosen a 5 year term at 3.75% and a 35 year amortization.) Now consider you decide to wait to buy and interest rates increase by a total of one percent to 4.75%. The outcome is that you would now qualify for approximately $43,000 less mortgage, or $307,000. Therefore, the purchase price of a home you qualify for is reduced accordingly. Most importantly though, you would need to rely on an equivalent (or better) percentage decrease in the purchase price of the home to offset the interest rate increases. And don’t forget that you might be paying rent while waiting, further compounding the home price reduction factor….
A compelling reason to take advantage of today’s low mortgage rates is to understand the effects of increased mortgage rates on your purchasing power. A sure thing right now is that mortgage rates are (again) close to all time lows. An unknown factor is where house prices are headed. To help you decide, seek the advice of your mortgage specialist and realtor.
Kevin Lutz, RBC Regional Sales Manager, Residential Mortgages
* In this chart we assume the following: (i) a constant interest rate throughout the amortization period, (ii) interest is compounded semi-annually for fixed interest rates and each payment period for variable interest rates; and (ii) the payment schedule you selected is maintained with no additional payments or skipped payments, unless selected by you. Royal Bank of Canada does not make any express or implied warranties or representations with respect to any information or results in connection with these calculations. Royal Bank of Canada will not be liable for any losses or damages arising from any errors or omissions in any information or results, or any action or decision made by you in reliance on any information or results.
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