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Headlines of many major metropolitan newspapers last week proclaimed the Federal Reserve Bank had lowered interest rates. The ‘Fed’ as its often called, consists of twelve district Federal Reserve banks, with 25 branches. All national banks are required to be members of the Federal Reserve system, and state banks may join if they meet membership qualifications.
What the ‘Fed’ actually did was lower its interest rate target on the federal funds member banks lend each other. Mortgage rates can be affected because the member banks pay more to borrow funds and may pass the additional cost on to the consumer. To buy now or wait until rates come down is the subject of many fence sitting conversations.
Each one thousand dollars borrowed today on a 30 year mortgage at 8.5% costs $7.68. Each one thousand dollars borrowed for the same term at 7.5% costs $6.99. The difference is sixty nine cents for each thousand dollars borrowed times the number of thousand dollars borrowed. On a one hundred thousand dollar loan the result is $69.00 per month or $828.00 more in one year on the higher interest rate. Looking at our example another way you might say by waiting one year you could save over eight hundred dollars. Pretty comfortable fence sitting you might say.
The question is what are you really saving by waiting? The government wisdom in recent years it seems believed raising interest rates lessens the potential for increased inflation. Apparently the government believes that if it costs more to buy a house, houses in general become less in demand and therefore the prices for houses will not increase as quickly or as much.
Let us assume the house you want to buy today is $100,000. If inflation raises the cost of the property by 5%, the price next year will be $105,000. Five thousand dollars at 7.5% interest equals $34.95 per month or $419.40 per year. If we subtract 419.40 from the $828.00 we could save by waiting until interest rates dropped, we are left with $408.60 or $34.05 per month, roughly one dollar per day.
Everyone likes to save money. If you’re on the fence waiting for interest rates to fall you may consider finding a more comfortable place to wait.
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