With more than 1,000 Inman posts, Bernice Ross is a long-time contributor whose weekly column on real estate trends, luxury, marketing and other best practices publishes every Monday.
Consumers are aware that interest rates are increasing, but very few understand how costly these seemingly small increases can be over the life of a 30-year mortgage. If your buyers are reluctant to buy now, they need to rethink their position. And it’s your job explain why.
Experts believe that interest rates will increase by another quarter point before the end of 2018 and that another three rate hikes will follow in 2019. This means today’s rate of 4.85 percent could be 5.85 percent a year from now.
This one-point increase is much, much bigger than most people realize, costing borrowers up to 23 percent more in terms of interest paid over a 30-year mortgage. Depending on the size of the loan ($400,000-plus), that amount could easily exceed $100,000 or more in additional interest.
Educate your clients now
If your buyers are waiting to purchase, here’s how to educate them about how costly that decision actually is.
- First, use an online mortgage calculator to determine their current monthly payment. Be sure to use an amortization calculator that also totals the amount of interest paid over the life of the loan.
- Repeat the process, except increase the interest rate one full point.
- Once you have found the monthly payment for each set of interest rates, multiply the monthly payment for each by 12 to determine the amount of the annual payment.
- Subtract the total amount of interest paid at the lower interest rate from the total interest paid at the higher interest rate.
- Create a chart like the one below to illustrate the difference in the costs of transacting now versus a year from now.
Example: For a $250,000 purchase price with $200,000, 30-year, fixed rate mortgage:
Understanding what higher costs mean
The rule of thumb for conforming Fannie and Freddie Mac loans is that your front end ratio (your proposed monthly payment), cannot exceed 28 percent of your income.
In the example above where the interest rate is 4.83 percent, to determine the front end ratio, divide the total annual payment by 0.28 (28 percent) to determine the total amount of income required for the borrower to qualify.
In other words, a borrower who makes approximately $45,129 annually in 2018 would have to make $50,443 the following year to qualify at the increased interest rate for the same $200,000 loan amount in 2019. (This is provided that their backend ratios, i.e., their total debt payments including, their mortgage, do not exceed 40 percent of their income.)
According to the amortization calculator, the difference in total interest paid over the life of the loan is $44,773 ($223,839 – $179,066) or approximately 23 percent of the entire loan amount.
If rates increase by 2 full points
If the rates increase two full points from 4.83 percent to 6.83 percent, the total interest paid over the life on that $200,000 mortgage will be $270,825.
That’s an additional $91,759 in interest or almost 46 percent of the $200,000 loan amount!
How to close buyers on transacting now
Buyers sometimes worry that prices may decrease. The current prediction from the National Association of Realtors (NAR) regarding price appreciation is that 2018 prices will be up 4.7 percent nationally and will increase by 3.1 percent in 2019 and 2.7 percent in 2020.
While these numbers will vary widely across the country, the average price gain is predicted to be 5.8 percent over the next two years.
Consequently, the true cost of waiting to purchase for one year would be the 23 percent of additional interest plus whatever the predicted increase in prices would be. Adding the 3.1 percent median increase above to the additional interest they would pay, that’s 26.1 percent.
Example: $250,000 purchase price today appreciates 3.1 percent to $257,750 in 2019.
Script No. 1: The declining affordability close
Prices are predicted to increase by 3.1 percent over the next year and interest rates are predicted to increase from 4.83 percent to 5.83 percent.
What this means in terms of your ability to purchase is that instead of being able to qualify with your income of $46,629 in 2018, you will need an income of $52,114 to qualify for the same home a year from now.
Will you be able to show that extra $6,985 in income this time next year? If not, you will have to settle for a less expensive home. It’s your choice — would you like to buy now or wait and be forced to buy something less expensive?
Script No. 2: Closing the buyer on long-term costs
Prices are predicted to increase by 3.1 percent over the next year and interest rates are predicted to increase from 4.83 percent to 5.83 percent. This means that the $250,000 home you’re looking at today will be worth $257,775 in 2019.
This means that you would pay $5,775 more for the same property next year plus an additional $46,209 in interest over the life of your loan.
In other words, the cost of waiting a year to purchase is $51,984. It’s your choice — buy now and save $51,984 in additional interest and appreciation costs or wait and settle for less next year.
If you’re uncomfortable calculating this for your clients, you can use the examples above to illustrate this point or ask your mortgage professional to do the calculations for you.
Keep in mind that it’s important you know how much prices are appreciating or depreciating in your area so you can provide accurate calculations.
This approach is probably the most powerful tool you can use to get buyers to purchase now. The cost of waiting is not just $128 per month. In this case, it’s well over $50,000 over the life of the loan.
Show your buyers the true costs, and chances are they’ll get off the fence and under contract very soon.
Bernice Ross, President and CEO of BrokerageUP (brokerageup.com) and RealEstateCoach.com, is a national speaker, author and trainer with over 1,000 published articles. Learn about her broker/manager training programs designed for women, by women, at BrokerageUp.com and her new agent sales training at RealEstateCoach.com/newagent.