For the last few years, we have been experiencing a heavy seller's market here in Orange County and Los Angeles County caused by housing shortages. We simply have not had enough homes for sale to meet the buyer demand, and this has caused a drastic increase in home prices.
However, there are clear signs the market is shifting. The Federal Reserve just announced that it is raising interest rates again. This is the third time they have increased rates this year, and more hikes are expected in 2022.
Higher interest rates matched with the increased prices can make purchasing real estate very challenging but not impossible. In this article, we will break down the real estate math to help you understand what is happening in today's market and how it affects the price and monthly payment for homes in LA and Orange County.
How Much Does Your Interest Rate Affect Home Prices and Monthly Payment?
The average home price in Orange County is just over $1,300,000 as of June 2022. Obviously, real estate prices can differ significantly by location. For simplicity's sake, let's assume you want to buy a house that costs $1,000,000 and you have $200,000 for your down payment. At 20%, $200,000 should mean you don't need to pay private mortgage insurance (PMI).
(A quick side note: you don't need a 20% down payment. You can often buy a home with less than 5% down.)
So after your down payment, you're borrowing $800,000 to purchase the home. How much will interest rates affect the monthly payment and the full amount you pay at the end of the loan, assuming you don't move or refinance.
7% Interest Rate
If you get a 30-year fixed-rate mortgage with a 7% interest rate, you can expect to pay $5,322 monthly on your principle and interest payment. For the total life of the loan, you'll pay a total of $1,916,071 plus the $200,000 you used as a down payment. This amount does not include insurance, property tax, and other expenses.
That's right. Your $1,000,000 house now costs nearly two million dollars. How does that happen?
Over the years, you paid a total of $1,116,071 in interest. You spent more money on interest than the actual property!
5% Interest Rate
In this scenario, everything stays the same, except you qualify for a 5% interest rate. You might not think that 2% seems like a lot. The numbers say otherwise.
With a 5% interest rate, you spend $746,046 on interest and a total of $1,546,046 buying the home. Lowering your interest rate by 2% saves you $185,012.45 over 30 years. Furthermore, your monthly payment drops more than a thousand dollars to $4,295. Think about all of the things you can do with that much money!
3% Interest Rate
In today's real estate lending market, you will struggle to find a mortgage that only charges a 3% interest rate. It isn't impossible, but it's becoming increasingly unlikely as the Fed raises its interest rates.
Still, let's assume that you can qualify for a 3% interest rate to see how much money you would save. At 3%, your monthly P&I payment is $3,373; over 30 years, you would pay $414,220 in interest. The total purchase, not including your down payment, comes to $1,214,220
Compared to a 7% mortgage, you save nearly $701,852. You save almost $370,000 compared to the 5% mortgage.
How to Get a Lower Rate
You can control some factors easier than others when you buy a home. When it comes to getting the lowest rate possible, consider some of these options.
- Compare rates between multiple lenders. When done correctly, you can get approved by multiple lenders without adversely affecting your credit.
- Save money for a larger down payment.
- Improve your credit rating.
- Utilize discount points to buy down your rate.
- Ask your agent about having the seller contribute to your closing cost to free up more of your cash for the downpayment or discount points.
Know What You Can Control
You can control some factors easier than others when you buy a home. For example, you can probably get a lower interest rate by saving money for a larger down payment and working to improve your credit rating. In the end, your lender will choose the rate, though.
You also don't have much control over home prices. You can expect to pay above the asking price in a seller's market.
However, you can control how much money you pay toward your mortgage each month. If your lender doesn't charge an early repayment penalty, you could save a lot of money by making a small additional monthly payment.
By contributing an extra $100 per month toward your mortgage, you save:
- $72,851.78 on a 7% mortgage
- $41,552.74 on a 5% mortgage
- $20,087.25 on a 3% mortgage
You will also repay your loan a couple of years earlier than scheduled. It feels really good to get out of debt and own your home outright!
