“If you don’t own a home, buy one. If you own one home, buy another one, and if you own two homes, buy a third and lend your relatives the money to buy a home.”
Words spoken from the mouth of a mad man? Not quite. The comments above were spoken to a standing-room-only crowd to the University Club in midtown Manhattan back in September, 2010, just four months ago. The speaker? None other than multibillionaire hedge fund operator John Paulson. You may know John Paulson as the man who engaged in the “greatest trade ever”, shorting the sub-prime mortgage market back in 2007. This one move earned Paulson & Co. over $3.7 billion… that year.
So here we are, January of 2011, and “the math” is making Paulson’s comments more and more realistic. Long-term interest rates are rising, and they’ll continue to rise for another several years. Where will they top out? No one knows for sure, but economically speaking, it makes sense to purchase a home this year after the significant drop in values since 2007. To prove the case, here are two scenarios that could very realistically play themselves out over the next 12 months:
Bob sees a home he likes at a current market value of $400,000 but decides to wait until January of 2012 to purchase, factoring in the potential for a continued decline in values. He happens to be right, with the $400,000 value dropping by 5% over the course of 2011. The same model Bob saw in January of 2011 for $400,000 is now worth $380,000 and he’s patting himself on the back for “saving” $20,000. Unfortunately, 30-year fixed rates have gone up to 6.0%, as predicted by many analysts in 2010 but ignored by our savvy buyer, Bob. While his property taxes are reduced because of the reduction in value, his payments are increased with the higher rate. His monthly tax payment of $395.83 (assuming 1.25%) plus his mortgage payment of $1,822.63 (6.0% and an 80% first mortgage of $304,000) add up to $2,218.46/month.
Bob is happy with his situation… until he talks to his next-door neighbor, Susan, who bought the same model as Bob one year before, back in January of 2011, when rates were lower…
Susan saw the same home Bob did and decided she loved it enough to move forward with the purchase, in spite of the potential for a continued drop in value. Like Bob, she put down 20%, but this was on a higher purchase price of $400,000. Susan locked an interest rate in January of 2011 at 4.875%. Susan was happy with her purchase, but still a little nervous about values dropping. To be honest, she thought about it on several occasions throughout 2011, wondering if she had made the right decision. Susan’s monthly tax payment was $416.67 and her monthly mortgage payment was $1,693.47 (4.875% and an 80% first mortgage of $320,000). This made her total monthly payment $2,110.14/month.
Yep, the math is simple: Susan’s payment is $108.32 less per month by having bought a year before Bob. Much to Bob’s dismay, it proves that Susan made the wiser choice in the end. And the kicker: Bob will end up paying $62,501 more in interest over the life of the loan, wiping out the $20,000 he thought he saved by waiting a year.
Now, it’s important to note that nobody can predict where interest rates will be in 2012, or if home values will continue to decline, but one thing is almost assured: rates can’t go down any more, they must go up eventually… the question is just when. As a homebuyer, it’s important to recognize the long-term value of historically low interest rates and take an active role in purchasing a new home in 2011. The time is now. Your time is now.
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