Metamorphosis Consulting, Inc.

Management Consulting Firm

Don’t Make Banks Your Private Charity

by

Don’t Make Banks Your Private Charity

All buyers, even investors, should consider the interest rate issue:

5.2%

April 2011

 

9.2%

2014?

 

7.2%

2012?

 

4.2%

Dec 2010

 

For every 1% interest rates increase, it costs borrowers approximately $0.60 per month for every $1000 they finance.

Formula = $0.60/$1000/month/1% 

  1. This doesn’t sound like much, but consider the following example where a buyer purchases a $300,000 home they plan on keeping for 20 years (240 months).  By purchasing now at 5.2% instead of in December, it now costs the buyer significantly more.

   $0.60

× $300

   $180/month

× 240 months

   $43,200 

In other words, in the above example, the buyer has lost $43,200 or over 15% of the purchase price.

Don’t repeat the same mistake!

  1. If the rate increases to 7.2% in 2012, the additional costs for the buyer would be:

  7.2%

– 5.2% now

2% ($1.20/thousand)

In conclusion, by saving $86,400 in mortgage interest, the net effect to a buyer is actually paying $213,600 for the house.

 

  1. If the rate increases to 9.2% in 2014, the additional costs for the buyer would be:

              $1.40

×               300

   420/month

× 240 months

$100,800

 

 

  9.2%

– 5.2% now

4% ($1.40/thousand)

In conclusion, by saving $100,800 in mortgage interest, the net effect to a buyer is actually paying $199,200 for the house.

  1. But, it’s a double-whammy!  Not only is a buyer giving too much money to the bank (their favorite charity, I guess), but in over 50% of the major markets, prices have already begun to rise.
  1. But, I’m paying cash.

No you’re not!  Consider taking advantage of other people’s money (OPM).  As the rates rise, having money that you borrowed at 5.2% will allow for a significantly higher profit.  This is also called leveraging an investment, and this should also be considered for conservative, secure investments.  It’s why one of the most successful hedge fund investors in history, John Paulson, says “Buy a home.  If you already own a home, buy another.  If you own 2 homes, buy a third.” This is great advice that comes from the guy who made $5 billion in 2010.