Tax Credit versus Interest Rates--Which has the Bigger Impact?

Real Estate Agent with Exit Realty Paramount

The 1st Time Home Buyer's Tax Credit is scheduled to expire 12/1/2009.  While it may be extended, I would say that there is an event coming that is of greater importance.  Interest rates are going to rise; it's only a matter of time.  An increase to 6% or more wouldn't be surprising.  That increase in interest will affect buyers and sellers alike.  Buyers will be faced with higher mortgage payments, or in order to control costs, they'll have to settle for lesser priced homes.  Sellers will find a market that is dampened by the higher interest rate, making a sale that much harder.  6% is still a very good rate, but to put it in perspective, let's look at how it will affect one's monthly payment. 

On a $200,000 mortgage, at a 5% interest rate, one's monthly payment (principal and interest only) would be $1074.  At 6%, that monthly payment would increase to $1199.  That's $125 per month extra, x 12 months = $1500 per year.  Over the course of a 30 year mortgage, that extra percentage point of interest translates to $45,164.   That's a huge difference, far outshadowing the maximum $8000 tax credit. 
So what's the moral of the story?  It depends on how long one plans to live in their new home.  If the intent is to sell within 5 1/2 years, then the tax credit has the bigger, more immediate impact.   If, however, one plans on remaining in their home for a longer period of time, then the interest rate has the bigger overall effect. 

Comments (5)

Dan Edwards 425-276-7008
Keller Williams Realty - Bellevue - Bellevue, WA

Chuck - that is a great point.  Not only the monetery diffenece... think affordability.  If your looking at a home worth 200,000 and rates are 5% and suddenly they are at 6% you now may only qulifiy for a home worth 185,000

That could be huge!

Oct 14, 2009 09:48 AM
Jon Budish
Resident Realty - Fort Collins, CO

I think interest rates are much more important, as they affect all buyers, not just first time buyers.

Oct 14, 2009 09:55 AM
Chuck Gollay
Exit Realty Paramount - Traverse City, MI

Dan:  You're right.  Buyers will likely be qualified for lesser homes.  There are still plenty of beautiful homes at that price, at least here in northern Michigan, but there is a difference in quality. 


Jon:  Great point!  I hadn't even thought of that myself. 

Oct 14, 2009 09:59 AM
James K Barath, CMPS
Canopy Mortgage, LLC - Crown Point, IN
FICO Pro, Certified Military Housing Specialist

Interest rates have the greater impact short and long-term. If interest rates were 7% which is where they were trending before the government got involved, would the $8,000 tax credit still be relevant? Home affordability would not be anywhere near the numbers they are now.

Using your example, a 7% rate would impact monthly cash flow by over $255 per month. This would require a borrower to earn 24% more on a monthly basis to qualify for the same home or would have look for a home priced at $161,000.

As you can see, $8,000 tax credit is really insignificant when compared to the impact of interest rates. In either case, consumers need to be educated and confident about their home purchase decision.

Oct 14, 2009 09:59 AM
Matthew Naumann
Exit Realty Charleston Group - Goose Creek, SC
Goose Creek, SC Real Estate Agent


Great Post. You are definitely correct. The good news if you act while the interest rates are low and the tax credit is available, you are really taking advantage of a great buying opportunity.

Thanks for sharing,

Matt Naumann

Jan 13, 2010 12:13 AM