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How interest rates can drastically affect real estate prices

Mortgage principal amount difference as related to interest rate graph

Do you know the power interest rates have over real estate prices? Well, they can drastically affect real estate prices and the profits you make on your properties, probably more than you realize. If you look at the graph just above, you will see that the total amount of mortgage that you can afford changes significantly (assuming you want to keep the same monthly payment) as interest rates fluctuate.

As an example, let’s take a mortgage payment of $1000 at an interest rate of 5% amortized over 30 years. With these numbers, you can pay a mortgage principal of $186,281.62. Now let’s increase the interest rate by 1% to 6%. If you want to maintain the same monthly payment of $1000, then you cannot sustain a mortgage of more than $166,791.61, making the mortgage principal amount 10.97% less than before. Let’s take a higher, more realistic interest rate, of around 8%, what difference does this make? Well you can now only afford $136,283.49 of mortgage principal, a significant drop of 26.8%.

Many people believe that what has driven the real estate market to today’s high prices is the investment value of properties, plain and simple, just like stocks in the dot com boom. However, if you ask someone walking down the street what started the boom, as in what exactly is the “investment value”, most won’t be able to answer you. Put fairly simple, housing got affordable really quick because interest rates dropped like a rock, to their lowest in decades! The reality is that for each 1% interest rates dropped, a person could afford a lot more mortgage with the same monthly payments, especially when the interest rates are on the lower side. That is what initially fueled the real estate market, however as the flames burned high, the market has taken a fire all of its own because people forget why the market started to get hot.

Mortgage percentage difference as related to interest rate graph

From the first graph we can extrapolate the data to create the graph just above.The good news is that we can see the mortgage principal drop to be more significant at first, so if you can ride it out for the first little while, you’ll probably be able to make some real money, pennies on the dollars. All those unfortunate souls that have been buying up real estate without really doing the research or working the numbers, or that are on the edge, will most likely get squeezed out and cause some over zealous fire sales, much like the dot com bubble and bust of 2000. For the smart investor, the next few years may become really fertile lands for making profits.

For your interest, I’ve added below the table used to compute these graphs (for a monthly payment of $1000):

Interest Rate (%) Mortgage Principal Amount Percentage Difference
4 $209,461.24 12.44
5 $186,281.62 11.69
6 $166,791.61 10.97
7 $150,307.57 10.29
8 $136,283.49 9.66
9 $124,281.87 9.07
10 $113,950.82 8.52
11 $105,006.35 8.01
12 $97,218.33 7.54
13 $90,399.61 7.11
14 $84,397.32 6.72
15 $79,086.14 6.35
16 $74,362.88 6.02
17 $70,142.20 5.71
18 $66,353.24 5.43
19 $62,936.92 5.17
20 $59,843.74 4.93

For the smart investor, the coming real estate bubble bust can be a great time to increase their wealth! And now that you know and understand how much interest rates can truly effect housing affordability, you are in a much better position to make some real money from this real estate bubble bust.

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    · February 11th, 2008  · 8:28 am  · Permalink

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