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New: The $64,000 Question

Posted on Apr 1, 2009


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I had a client the other day ask me about the real estate market and waiting for the bottom.  In this case he was hoping for real estate prices to come down so he could buy at a lower price.  I told him that was a great idea, but it is really tough to time the market and that many professionals get that type of thing wrong, so I would be wary of trying.  In his case he was looking for a $200,000 house, and a 5% price reduction which represented a $10,000 difference in the cost of the house.  We agreed that was a lot of money.  However, I told him that if the bottom of the market was already here, and we just didn’t recognize it yet, waiting longer could cost him a bunch more.

I explained that once the housing market bottoms and we see the market for homes stabilize, demand will increase and we will probably see a significant amount of buyers since plenty of people have had the same thoughts about waiting for the market to bottom.  Because of that we could see prices rise quickly.  This would actually not be the most costly part of the market shift. As things get better, the government will no longer have the incentive to keep interest rates low, and they will stop sinking hundreds of billions of dollars into the Mortgage Backed Securities market (MBS-these are the assets that are made when banks pool the mortgages that you and I pay every month)

Once the government stops funneling money into these MBS markets, interest rates will rise, and even if they only go back to levels just before the government stepped in that would represent a 1.5% increase in interest rates from where we are now.  FYI, that initial interest rate drop from the mid 6% range down to the mid to high 4% range happened in less than 1 week in Dec. 2008.

So back to my client and his $10,000 price drop.  We decided that $10,000 was a lot of money.  However, if the interest rate on his purchase goes up 1.5% from where we are now to when he decides to make the purchase (assuming he can still get the house for the $200,000 list price) he could expect about a $64,000 increase in the interest cost over the life of the loan.  Now that is a lot of money!

If the state of the economy is teaching us anything, it is that you can’t just look at short-term benefits.  Sure, it is great to get what you want today, but you also have to keep an eye on what it will cost you tomorrow.

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