With the change in interest rates lately, there has been a popular slogan being pushed towards home buyers that says one should “marry the house, and date the rate.” The idea being that you should not worry about the current interest rate, as you can always refinance when the rate drops later. Instead, focus and commit to the house you want to buy. Has a nice ring to it, no?
In theory it sounds nice and simple, but in certain scenarios it might cost you more in the end. As with everything else, home buyers need to do their homework and figure out their own best scenario. Not everything is one size fits all. Buying a home can be the biggest buying decision one can make in their lifetime, and deserves proper attention.
Jon Brooks recently published one such scenario where he explained how this friendly slogan could actually be costly for home buyers. Here was his example:
The Assumptions.
If you buy a house for $400,000 today and put 20% down ($80,000), you'll have a $320,000 loan balance. Let's say you locked in a great rate of 6.5%. With these inputs your monthly payment would be approximately $2,675 (including taxes and insurance).
Private Mortgage Insurance.
You saved up and put 20% down (80% LTV) on your mortgage so you could waive private mortgage insurance (PMI). Your mortgage insurance that you avoided ranges from 0.58% to 1.85% depending on your credit score, loan-to-value (LTV) ratio, and debt-to-income (DTI) ratio. So let's just meet in the middle and say your PMI is 1%.
Housing Price Expectations.
Now, the base case for most economists is that home prices will drop 10-15% in 2023 due to rising interest rates, which destroys buyer demand, and causes listings to stack up on the market. more supply = more competition = lower prices. This could mean if you buy a house today for $400,000, it's very likely it could be worth $360,000 next year (let's assume 10% less). Your principal pay down over your first year was only $3,576. Meaning you lost net equity of $36,424.
The Costs of Refi & PMI
Now let's say that mortgage rates also went down from 6.5% to 5.0% (unlikely but possible) and you try to refinance your interest rate in late 2023 or 2024. You now have to pay 2% in closing costs again to complete the refinance, which is $6,400. Your new monthly payment is $2,348, a good $327 less in a monthly payment, BUT now since your house is worth less, during your refinance you found out you have to either bring $36,424 to the table to make the LTV 80% to avoid the PMI again or actually pay the PMI, which is $266 per month.
If you don't have the money to bring to the table to close the refi, tough luck, your new PMI from your refi has eaten up 81% of your savings from the refinance. It still helps - but you have to pay the closing costs again to refinance. If you do have the money to refinance plus pay the closing costs, good for you.
Most Americans do not have $36,424 (equity loss) plus $6,400 in closing costs to bring to the table to lower their monthly payment by $327 per month. And, even so, most people wouldn't pay this money out of pocket to change the payments by that amount.
As much as we would like to live in a world of simple slogans, Jon Brooks’ example confirms that home buyers need to constantly sharpen their pencils and figure out what works best for them. The more work done during the home buying process, the happier one will be with their purchase.