In my last post I talked about using leverage to buy into real estate. I’d now like to talk about using interest rates to increase your purchasing power. That means we’ll need to do a little math.
Before I begin I would like you to know that it is best to talk with a loan specialist before you begin your hunt for a home. While I can paint a rough picture of your financing, the loan specialist will be able to provide more exact numbers for your interest rate and payment amount.
For my examples I used an online mortgage calculator I found through a search engine. My examples may not include APR or annual percentage rate. They are not intended as an offer of financing.
With a little math we are able to find a starting point for your mortgage payment. As a rough rule of thumb your mortgage payment (principle, interest, taxes and insurance) should be about one-third of your before tax income. Take your monthly gross (before tax) income and multiply it by 33%.
Let’s set aside the tax and insurance costs for now and assume that you qualify for a principle and interest payment of about $1010 per month. At 4.5% that translates into a loan amount just under $200,000. But at 4% that translates into a loan amount just over $212,000. A simple one-half point decrease in the interest rate increased your buying power by about 6%.
Turning that around…with an interest rate of 4.5% your principle and interest payment on a $200,000 loan would be about $1014 and at 4% your principle and interest payment would be about $955. That’s a $59 savings every month just by having a lower interest rate.
There are a myriad of factors used to calculate the actual interest rate you will pay. Until they change the credit rating system your FICO score will be the single most important factor. Think, higher FICO equals lower interest. Work with your loan specialist to find ways to increase your FICO score. And do so long before you begin to hunt for a home.
Improving your FICO score is one way to obtain a lower interest rate. Buying down the interest rate is another. However, before you start spending money to save money, do a little more math. To see what you will really save you’ll need to calculate the monthly savings then determine how long you’d need to hold the property to actually save money. Here’s an example using the $200,000 loan;
You pay 1% of the $200,000 or $2000 to buy down the interest rate from 4.5% to 4%. Your payment goes from about $1014 to about $955. You save about $59 per month. Divide the $2000 initial investment by the $59 per month savings. In about 34 payments you’ll have saved the $2000 you invested and will begin to save money on the loan.
Do you plan to live in the property for 2.9 years? If the answer is yes, then by all means seriously consider buying down your interest rate.
Just as interest rates vary from hour to hour and lender to lender so will “buy down points”. I suggest to all potential home buyers that they contact at least three lending specialists. Ask for a good faith estimate from each so that you will know “the other fees”. Sometimes a lender will advertise an enticing interest rate and will make up the difference by charging higher fees.
Another difficult to execute but effective method for improving your buying power through lower interest rate is to watch interest rates and time your purchase with falling rates. Of course, if you have the ability to see into the future, I doubt you worry much about interest rates.
Currently interest rates are bouncing around at historic lows making now the perfect time to maximize your purchasing power. If you think rates are due to rise in the near future, call me. If you need help finding a proven loan specialist, call me. I can help you get you into your new home before we have to worry about rising interest rates.