Would You Rather Have a Low Mortgage Rate or Pay a Lower Price for a Home?

My friend asked me the other day if I’d rather have a low mortgage rate or pay a lower price for a home.

I paused briefly, then said I’d rather pay less for the home. My thought process was basically that the price you pay for a home will never, ever change, whereas mortgage rates can and do change quite often.

Put another way, you can’t change what you paid for a home, but you can change the financing (mortgage rate) as often as you’d like via a mortgage refinance, assuming it’s favorable to you.

In that respect, it makes sense to go with the lower price tag as opposed to the lower mortgage rate.

A lower home price also means a lower down payment, something that is often more difficult to get around than a monthly payment.

There are Lots of Scenarios to Consider…

• There isn’t just one scenario here
• Let’s look at a few different possibilities
• To see if low home prices or low mortgage rates
• Are more powerful

What If Home Prices Fall 5% and Rates Climb 0.5%?

Let’s pretend home prices fall about five percent as mortgage rates climb a half a percentage point. It should be noted that there’s no direct correlation between rates and prices. They could both easily rise in tandem. But let’s just see how it might look.

$237,000 purchase price
20% down ($47,400)
$189,600 loan amount
3.5% rate = $851.39 monthly payment

Total principal paid after 84 months: $28,355.44
Total interest paid after 84 months: $43,161.32
Principal balance after 84 months: $161,244.56

$225,000 purchase price
20% down ($45,000)
$180,000 loan amount
4% rate = $859.35 monthly payment

Total principal paid after 84 months: $25,093.20
Total interest paid after 84 months: $47,092.20
Principal balance after 84 months: $154,906.80

As you can see from the example above, the lower priced home with the higher mortgage rate requires a lower down payment, has a very slightly higher mortgage payment, and has a lower principal balance after seven years.

So maybe that higher mortgage rate isn’t so bad.

For the record, I chose to look at the seven-year mark because most people don’t stay with their homes or mortgages for the full 30 years. Or even 15.

What If Home Prices Fall 10% and Rates Rise 1%?

Now let’s assume home prices fall 10% and mortgage rates rise by a full percentage point.

$405,000 purchase price
20% down ($81,000)
$324,000 loan amount
3.5% rate = $1454.90 monthly payment

Total principal paid after 84 months: $48,454.91
Total interest paid after 84 months: $73,756.69
Principal balance after 84 months: $275,545.09

$365,000 purchase price
20% down ($73,000)
$292,000 loan amount
4.5% rate = $1479.52 monthly payment

Total principal paid after 84 months: $37,883.13
Total interest paid after 84 months: $86,396.55
Principal balance after 84 months: $254,116.87

Obviously, the lower priced home with the higher mortgage rate would still require a lower down payment. The mortgage payment would be slightly higher, by about $25, but would have a much lower principal balance after seven years.

So again, home price is paramount, and mortgage rate, while somewhat impactful, pales in comparison.

What About a 20% Home Price Drop and a 2% Mortgage Rate Increase?

Let’s get more extreme. A 20% home price drop and a 2% mortgage rate increase!

$500,000 purchase price
20% down ($100,000)
$400,000 loan amount
3.5% rate = $1796.18 monthly payment

Total principal paid after 84 months: $59,821.54
Total interest paid after 84 months: $91,057.58
Principal balance after 84 months: $340,178.46

$400,000 purchase price
20% down ($80,000)
$320,000 loan amount
5.5% rate = $1816.92 monthly payment

Total principal paid after 84 months: $35,788.66
Total interest paid after 84 months: $116,832.62
Principal balance after 84 months: $284,211.34

In this third example, the down payment is again much lower on the cheaper home, and the mortgage payment is only about $20 higher despite the rate being a full two percentage points higher, the principal balance is also significantly lower after seven years.

Or a 5% Drop in Home Prices and 2% Mortgage Rate Jump?

How about just a 5% drop in home prices and a 2% mortgage rate increase.

$500,000 purchase price
20% down ($100,000)
$400,000 loan amount
3.5% rate = $1796.18 monthly payment

Total principal paid after 84 months: $59,821.54
Total interest paid after 84 months: $91,057.58
Principal balance after 84 months: $340,178.46

$475,000 purchase price
20% down ($95,000)
$380,000 loan amount
5.5% rate = $2157.60 monthly payment

Total principal paid after 84 months: $42,499.82
Total interest paid after 84 months: $138,738.58
Principal balance after 84 months: $337,500.18

Whoa, a $362 jump in monthly payment in exchange for a down payment just $5,000 lower. Ouch! At least the principal balance is a bit lower after seven years.

What If Home Prices Rise 10% and Mortgage Rates Fall 1%?

Now let’s look at it the other way –  a 10% rise in home prices and a 1% mortgage rate decrease.

$500,000 purchase price
20% down ($100,000)
$400,000 loan amount
3.5% rate = $1796.18 monthly payment

Total principal paid after 84 months: $59,821.54
Total interest paid after 84 months: $91,057.58
Principal balance after 84 months: $340,178.46

$550,000 purchase price
20% down ($110,000)
$440,000 loan amount
2.5% rate = $1738.53 monthly payment

Total principal paid after 84 months: $75,360.00
Total interest paid after 84 months: $70,676.52
Principal balance after 84 months: $364,640.00

While the chances of a 2.5% 30-year fixed rate are slim to none, it would result in a slightly lower monthly payment, albeit with a larger down payment.

As a result, you’d pay down the principal balance a lot faster, but still wind up with a higher outstanding balance after sever years versus the cheaper home.

Is House Price or Interest Rate More Important?

• The price you pay for a home will never change
• And as such it is paramount
• It also dictates what you’ll pay in property taxes
• Mortgage rates on the other hand can rise and fall over time
• And you always have the opportunity to refinance
• Assuming you have good credit, employment history, and assets

The point here is that while low mortgage rates are awesome and money-saving, they aren’t everything. Yes, if you have a high interest rate and can refinance to a significantly lower rate, it’s a good thing. That’s not debatable.

But if you’re buying a home for a lot more money today than what you could have purchased it for yesterday, or tomorrow, a super low interest rate often won’t do enough to offset the higher price tag.

Of course, it’s still better than paying a high home price and a high mortgage rate.

And there are cases where a small price drop and a large mortgage rate increase will change the logic, as seen above. Though that might be telling of what’s to come.

There are many other examples where the monthly payment difference based on rate will be marginal compared to the big jump in down payment.

A higher purchase price means a larger down payment is necessary, something many Americans can’t muster as it is. That could mean a higher LTV ratio, which could result in added costs such as mortgage insurance.

Additionally, you can’t take back the price you paid for a home, whereas you can change your rate via a refinance or simply sell the property before the full 15 or 30 years are up.

The million-dollar question is will home prices come down if rates go up a lot. And if so, how much and how fast? History isn’t very clear on this, so it might not be a good idea to play that game.

(photo: Véronique Debord-Lazaro)