SubscribeThu 27 Dec 2007
As I announced last week I’m making a home purchase. I actually locked in a rate right before the Christmas, though I wish I locked in rate a week before I actually did. During the week of 12/3/2007 rates were some of the lowest we’ve seen in a long time. However at that time I hadn’t even agreed to a purchase price. I wasn’t comfortable locking in rate without knowing that I would actually be purchasing a place. Had I locked on December 5th when I started shopping around, I could’ve gotten a 15 year fixed rate mortgage for 5.25%. Instead I locked in rate of 5.5% for a 15 year or 5.875% for a 30 year mortgage.
While it’s probably not a good idea to “time” a mortgage rate, that doesn’t mean that a sense of timing isn’t important. Mortgage rates tend to track the 10 year U.S. bond (or the 30 year bond). Below are two charts. T he first chart is of rates for a 30 year mortgage from bankrate.com for the last three months. The second chart is for the 10 year bond for the last three months from Yahoo Finance. Awfully similar wouldn’t you say?
Predicting where rates will go is difficult, but knowing that rates are good doesn’t have to be. There is natural bottom for interest rates - 0%. Nominal rates will never be lower than this. Below is a chart of the yield on the 10 year bond for the last 5 years.
You’ll never know if you’re at a bottom of a dip, but you can know that you’re in a dip. Generally speaking when buying there’s not really an opportunity to “time” the rate. The timing of the rate is generally determined by the circumstances of the purchase. Timing is much more important for a refinance. Given that even a no closing cost refinance actually does cost something, there’s something to be said for getting the timing right. The no closing cost refinance is only seemingly costless because the person refinancing gives up something on the interest rate. There’s inherent value in the option of being able to refinance at a later date.
This isn’t my first real estate purchase so I had experience with mortgage shopping. The previous experience with both purchasing and refinancing twice proved extremely helpful this time around both shopping for a rate and having a better understanding exactly what different trade offs were. You can look forward to a more extensive post on my mortgage shopping experience.
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December 28th, 2007 at 1:03 am
Hi Dong,
I couldn’t tell if you were planning to go with the 15 or the 30 year mortgage?
Also, I’m curious if you are going to tackle the closing costs by increasing your rate or just paying it out.
Hope all is well with you.
December 28th, 2007 at 12:14 pm
Pf, I haven’t decided myself. I basically can pick either the 30 year or the 15 year right now. I do have to make the decision before closing, but still have a couple weeks to think.
As for closing costs. I plan on paying my closing costs. I don’t think there’s a right or wrong decision on that. It’s question of preference, cash position and how long I think I’ll own the place. Each of which can be constantly changing.
December 30th, 2007 at 11:45 am
Some “food for thought” as you consider what you’ll do:
1) In regard to the 30 year vs 15 year mortgage:
- Cashflow. If you need a lot of flexibility as far as cashflow, I think you would strongly consider the 30 due to the payment being significantly less than the 15. There is a little bit of forecasting here. If you lose your job, can you find replacment income pretty quickly in order to swing your mortgage payment? Can you imagine any significant expenditures that would require additional cash in the intermediate term (ex: more schooling, other investments, etc)
- Investments. A mortgage is the cheapest money you’ll probably ever borrow. Let’s say there was a $300 difference in your monthly mortgage payment between a 30 and 15. If you would invest that difference in POTENTIALLY higher yielding investments (ex: equities), then I might suggest the 30 so you can pursue the higher returns.
- Asset Allocation. This is somewhat similar to the above. Generally, you have many pots in which to place your money. How much do you want to put into the real-estate pot versus the alternatives?
- Psychological. I currently have a 15 year mortgage and it feels fantastic to see the $750 of principal that gets paid off every month. You won’t see that in a 30 year mortgage for a long time. Of course, this has come with a trade-off as I could have clearly made more money had I invested it in other alternatives instead.
In regard to the pay or not pay on closing costs, again, you have to think about the future a bit.
A) Do I think that is likely that I will have an opportunity to refinance my mortgage at a much better rate within the next few years or do I think I am likely to move in that timeframe? If the answer is yes, then keeping the cash and accepting an increased rate may be the better option.
B) Do I think that rates are not likely to go down signficantly or do not anticipate a move anytime that I can now foresee? If the answer is yes, then go ahead an pay your penance now and reap the rewards of lower interest for years to come.
There are surely other considerations, but these are a few I think are key. I suspect you have already considered most of them, so consider it more as reinforcement that you aren’t missing anything.
Unfortunately, I do think the decision process is a lot like the Roth vs 401(k) in that you are trying to predict the future (interest rates or your personal situation versus taxes). It sounded like the pinch on your finances wasn’t that big (cashflow), so I suspect it will really come down to your own personal preference…what makes you feel good and fits your risk tolerance. I’ll be interested to see.