Should You Buy a Home or Consolidate Debt when Interest Rates are High?
By Thuong Thien, CFP
Interest rates were raised by the Federal Reserve for the sixth time this year, including 75 basis point increases in June, July, and September, to slow inflation. Then in November, the target range for the federal funds rate increased to 3.75% – 4.00%. Although that won’t affect any existing debt you hold at fixed interest rates, it can impact your finances…and your quest to buy a home.
Thuong Thien
So, intuitively, this may not be the time to apply for a new loan. However, suppose you believe you’re ready to buy a home or hold existing debt at variable interest rates. In that case, there are strategic ways to manage your finances so you don’t become overburdened by high interest.
Should you buy a home now?
The homebuying market has presented a pickle of late. This fall, as home prices were beginning to wane, mortgage interest rates leapt to more than 7% on a 30-year fixed loan and nearly 5% on the 10 Year ARM (an adjustable-rate mortgage that guarantees a fixed interest rate for the first ten years).
However, there are a lot of factors in today’s home-buying equation. The Fed is expected to continue raising interest rates in the coming year, albeit perhaps not quite as aggressively. This may cause a drop in home prices to attract more buyers. In contrast to the booming residential market of recent years, this scenario presents an opportunity to buy at lower prices – which can help offset the pain of monthly payments at a higher interest rate.
Ultimately, there are three main factors to help you decide if you should buy a home now:
- You have a strong desire or a need for a house (e.g., a need for more bedrooms because your family is growing).
- You have at least 20% down payment.
- You’ve calculated the monthly all-in cost of owning a home and your family’s salary can support it, along with all other expenses in your life.
Below is an example. I didn’t put in maintenance cost but if your home is older, you can estimate how much that might be on a monthly basis.
Monthly cost of owning a home:
$1.5 million purchase price, 20% down payment, 5% 10-year ARM:
|
Mortgage (principal & interest) |
$6,442 |
|
Property Tax (1.15% in San Mateo County, CA) |
$1,438 |
|
Basic homeowners Insurance |
$100 |
|
Total |
$7,980 |
The most prudent interest rate is a 30-year fixed. However, in the current environment, you may want to consider a 10-year ARM instead. I’ve heard it several times now from realtors, “You date the rate, and you marry the house.” In other words, hopefully rates go down and you can refinance.
Is it smarter to continue renting and delay buying? That depends on how much you’re paying in rent. According to analysis by the Dallas Fed, rent inflation tends to lag rising home prices by about a year. Based on the state of the housing market last spring and throughout the summer, the Fed projects rent inflation will continue to increase – from 5.8% last June to 8.4% in May 2023, at which point rents should begin to drop again.
However, your rent won’t change until the end of your lease. While you may be able to negotiate a new lease rate, it’s not likely to be less than what you’re paying now. You can shop for a cheaper rental or get prequalified to see how much house you can afford. You may find a well-priced home that’s worth paying today’s higher interest rates. If you find a home you like in your price range, you can always buy now and refinance later.
Should you consolidate debt?
Let’s talk about existing debt, particularly the impact of high interest on credit card balances. According to CreditCards.com, the average credit card interest rate in November topped 19%. In addition to higher minimum payments, that interest will increase your balance by leaps and bounds. Now is the time to be aggressive about paying it off. You have some options for this.
For example, you might take advantage of a balance transfer offer from another credit card that waives interest for six months or longer. Be sure to note how much you’ll pay in a transfer fee, which is generally a percentage of the balance conveyed. If you go this route, remember that the key is to pay off that balance before the term is up, when you’ll switch to paying a high interest rate. If your plan is simply to get temporary payment relief, this strategy may not be in your best interest. Between the transfer fee and higher interest down the road, you could be worse off.
Another option is to consolidate your debt with variable interest rates into a…
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