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Jay Money Powell hasn’t been letting the money printer go brrrr lately. In fact, yesterday he raised interest rates for the 4th consecutive time, bringing them to levels not seen since 2008.
Although it can seem like the recent Fed Funds increases have no impact on your day to day life, I wanted to take a second to show you just how impactful the recent rate hikes are. And I can’t think of a better way to do just that than through the study of home price affordability today vs four years ago. Back in 2018, when I purchased my home, it was common to lock in rates for 30 year mortgages at 3.99% and lower. Today, you can’t close on a 30 year mortgage at a rate lower than 7.6%.
Let’s examine a home purchase.
Assume you’re buying a house; for example, this one here.
If you bought this home today at a sale’s price of $202,000 and an interest rate of 7.6% you’d have a monthly payment of $1,426.27, excluding taxes, mortgage insurance, and home insurance. And when you went to make your first payment on the loan, you’d pay $1,279.33 in interest and $146.94 towards the principal.
If you bought this home four years ago at a sale’s price of $202,000 and an interest rate of 3.99% you’d have a monthly payment of $963.21, excluding taxes, mortgage insurance, and home insurance. And when you went to make your first payment on the loan, you’d pay $671.65 in interest and $291.56 towards the principal.
Understanding that all variables to this deal are the same between four years ago and today except for the interest rate, when you run the numbers the variations between the two deals is quite drastic.
In fact, it is nearly a 50% increase in monthly payment.
More specifically, at your first payment you will pay 50% more towards interest and 50% less towards equity.
What an incredible change!
You can use this Google Sheets financial model to analyze that I created to model the cost of your home from when you purchased it versus today.
Below is what the model looks like. You can click here to edit its variables denoted by blue text.
With no significant decrease in home prices expected in the short term, you have to congratulate those that executed a home purchase when rates were low. This is because not only have those purchasers likely experienced a significant uptick in their home’s value, but they are also enjoying significant month to month savings on their financing resulting in more free cash flow for spending elsewhere.
However those that weren’t able to participate in buying a home before these rate increases or those that otherwise sold their home to cash in on equity likely will be the losers in the long run. The obvious loss of securing cheap financing is one thing. But specifically for those that withdrew the equity in their home, they face the challenge of finding investment alternatives that can outpace the record levels of inflation that we are experiencing as well as the harsh reality that when they go to re-enter the real estate market a savings will not likely be realized between the price they previously sold their home for and the price in which they would need to pay to re-purchase it. Put that in combination with the significantly higher financing cost that they are likely to absorb and you find yourself in a bad situation.
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