1980s house

Were you alive in 1980? Maybe you weren’t, but maybe your parents were. Ask them what they paid for a house back in those days.

Back then, in a lot of places in the United States, $100,000 was a lot of money for a home. Also back then, somebody taking out a loan to buy such a house probably landed a 30-year mortgage with an interest rate somewhere in the neighborhood of 18 percent, give or take.

A $100,000 home loan with an interest rate of 17 percent would cost a household $1,426 in principal and interest per month. These days, a $100,000 loan at a very attainable rate of 3.75 would equate to just $464 per month. That means that 36 years ago, the same home loan cost nearly $1,000 per month more. And that $1,426 was in 1980 dollars, so figuring inflation into the mix, the gap is even wider. In fact, it’s more a chasm than a gap.

For $1,426 per month today – again, forget inflation – you could finance $260,000 worth of home.

Which leads us to an important question, given today’s climate of rapidly rising home prices and near rock-bottom rates: What’s more important, a home’s price or the interest rate on a loan?

In terms of initial impact, qualifying for a mortgage doesn’t depend on either or. It depends solely on whether one can afford the monthly payment. It doesn’t matter if it’s a $100,000 house or a $200,000 house. If you can afford the monthly payment, you can qualify for the loan. In the example above – an exaggerated one, for sure – the lower rate makes the home much more affordable.

But in a different, more realistic, example, it can be almost as big. Let’s say you were looking for a home in 2007, when rates were around 7 percent for a 30-year, fixed-rate mortgage. If you qualified for a $100,000 loan then, your P-and-I would come out to about $667 on a $100,000 loan. Today, at the aforementioned 3.75 percent, and all other circumstances the same, you could qualify for a $144,000 loan.

I have always said that the most important factor in deciding to buy a home is whether you can afford it. And affording a home involves first and foremost the monthly payment. In those terms, it doesn’t matter which – a low purchase price or lower interest rate – allows you to afford the monthly payment.

But down payments also fall into the affordability category. Maybe you qualify for that $144,000 loan, but buying more house also means putting up more cash up front for a down payment. And down payments are determined by purchase price, not interest rates.

Let’s assume, for sake of simple math, that you’ve got a loan product with a 10-percent down payment. On that $100,000 loan you qualify for at 7 percent, that means a max purchase price of around $111,000. Your down payment would be around $10,000.

On that $144,000 loan you can get because rates are at 3.75 percent, 10-percent down would mean a purchase price of $160,000. That means that with a 10-percent down payment, you’re looking at a $111,000 home vs. a $160,000 home – not a small difference. The difference in the down payments, however, is $6,000 -- $10,000 vs. $16,000.

That means for an extra $6,000 up front, you can afford a home that costs $49,000 more. It’s nothing to sneeze at.

There’s never an exact, perfect time to buy a home if you’re simply looking to maximize your savings. You have to take into account your ability to afford it now and in the future. You have to take into account how long you’re planning on staying – and the longer you plan on staying, the more important the interest rate is relative to the down payment amount. You have to plan on repairs and maintenance, as well as your ability to maintain an emergency fund.

A higher down payment is one-time thing. A lower interest rate on a fixed-rate loan, is a monthly savings that lasts as long as 30 years.

Affordability is a personal situation. Banks can give you ratios and that sort of thing, but it’s up to you to determine what you are comfortable spending. In reality, for most people a $100,000 price vs. $120,000 isn’t as important as what it costs, in actual dollars, out of your wallet each and every month.