Track the companies that matter to you. It's FREE! Click one of these fan favorites to get started: Apple; Google; Ford.



Mortgage Rates: Why 2014 Is a Great Year to Buy a Home

Right now is a great time to buy a house.

To understand why, I encourage you to spend a moment contemplating the chart above. What it shows is that the interest rate you pay on a mortgage matters a lot when it comes to the ultimate price of the American dream.

Let's assume you buy a $250,000 house by making a 20% down payment and financing the rest with a 30-year fixed-rate mortgage. At the average historical mortgage rate since 1971 -- 8.52% -- the house would end up costing you $604,760 in interest and principal payments. By contrast, at the rate prevailing today -- 4.13% -- the total cost of the house comes out to only $399,200.

As you can see, buying a house this year could save you more than $200,000 in interest expense alone if mortgage rates ever revert back to their long-run average.

Housing affordability
When mortgage and housing industry experts discuss this, they refer to affordability -- more specifically, to the National Association of Realtors' housing affordability index.

This widely followed metric factors in mortgage rates, housing values, and income data to determine whether a typical American family can afford to purchase a median-priced home. The higher the index value, the higher the affordability.

For example, a reading of 145 indicates that a family with a median income has 45% more earnings than necessary to afford a median-priced home. By contrast, a reading of 80 suggests that a typical family earns 20% less than needed to shoulder the cost of the same dwelling.

Where are we right now? According to the most recent preliminary reading, the current index value is 159.3. By this measure, homes are 27% more affordable now than they've been on average over the last 33 years -- the mean since 1981 is 124.8.

Affordability is heading down
It's important to appreciate that this situation won't last forever.

In the first case, it seems safe to assume that mortgage rates will head higher over the coming years. This follows from the fact that the Federal Reserve is scaling back its support for the economy -- which, almost by definition, means long-term interest rates are bound to trend higher.

We got a taste of this in the middle of last year. After Fed Chairman Ben Bernanke intimated that the central bank would begin to taper its third round of quantitative easing, the average rate on conventional 30-year mortgages went from less than 3.5% up to nearly 4.5%.

That might seem nominal, but rest assured it's not. Take our scenario from the chart at the top of this article. In one fell swoop this uptick increased the total cost of a $250,000 house by 16% or $41,400 (again, this assumes a 20% down payment with the remainder financed by a mortgage).

Adding insult to injury is the fact that home prices are heading up as well. In its latest estimate, the S&P/Case-Shiller 20-city home-price index posted an annual gain of 10.8% in April. Some cities -- namely, Dallas and Denver -- are even above their pre-crisis peaks.

The good news for homebuyers is that the rate of home-price appreciation is beginning to slow down. At this time last year, home values in the sunbelt cities were posting year-over-year gains of 30%. Now, they're all below 20%.

At the same time, however, they're still moving higher. According to David Blitzer, chairman of the Case-Shiller index committee, "Near term economic factors favor further gains in housing."

The bottom line on home buying
My point is that these two forces -- rising mortgage rates and increasing home prices -- will continue to work against housing affordability. And as housing affordability decreases, it stands to reason that it'll become more challenging for people to realize the American dream of homeownership.

Does this mean you should immediately go out and buy a home today? Obviously not. But what is does mean is that if you were on the fence about doing so before, then now may be a good time to go ahead and pull the trigger.

Risk-free for 30 days: The Motley Fool's flagship service
Tom and David Gardner founded The Motley Fool over 20 years ago with the goal of helping the world invest...better. Their flagship service, Stock Advisor, has helped thousands of investors take control of their financial lives and beat the market. Click here to sign up today.

Read/Post Comments (6) | Recommend This Article (8)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 04, 2014, at 1:06 PM, ballengerm wrote:

    Aren't low mortgage rates one of the primary factors in the current rise in home prices? Won't home prices drop or at least stop rising once the Fed starts raising rates?

  • Report this Comment On August 04, 2014, at 1:38 PM, mstrb2000 wrote:

    Investors have stopped buying. If rates rise, sellers will have no choice but to lower their prices to allow buyers to afford the mortgage. Hold off, especially if you are a cash buyer.

  • Report this Comment On August 04, 2014, at 6:49 PM, vv234 wrote:

    Either the author is writing on behalf of the realtor association or he has no clue what he was talking about in this article: the housing prices are above the housing bubble peak in many states right now and he thinks it's the best time to buy! Yes, the prices will continue to rise for now but could it do so forever? Have we forgot how the housing bubble got created in the first place?

  • Report this Comment On August 05, 2014, at 11:49 AM, anash91 wrote:

    I bought my house earlier in the year at a discount to the market (homes in my area are worth around 30k more than what I paid) I had to put a few thousand dollars into it, but I love living by myself at the age of 23.

  • Report this Comment On August 05, 2014, at 1:50 PM, hgraphic wrote:

    I wish I knew what's coming, but I personally am very afraid of investing or making major purchases right now. Seems to me the time to buy was two or three years ago.

    What little I know is that interest rates could go through the roof (no pun intended) very soon, thus collapsing the real estate market over night.

    Our paper tiger of a monetary system is progressively getting worse and I don't have any faith in the unconstitutional FED, and especially the current administration.

  • Report this Comment On August 05, 2014, at 1:51 PM, hgraphic wrote:

    wish I could be a bit more upbeat, sorry!

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 3047376, ~/Articles/ArticleHandler.aspx, 8/31/2015 1:58:18 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

John Maxfield

John is The Motley Fool's senior banking specialist. If you're interested in banking and/or finance, you should follow him on Twitter.

Today's Market

updated Moments ago Sponsored by:
DOW 16,553.50 -89.51 -0.54%
S&P 500 1,976.92 -11.95 -0.60%
NASD 4,803.95 -24.38 -0.50%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes