I've been playing around with mortgage calculators this morning, after getting an email from a renter in Long Island who wants to buy but isn't happy with falling mortgage rates:
I have saved enough for a substantial down payment - and was looking forward to taking advantage of my savings and higher mortgage rates by buying a home for a lot less than current asking prices.
Lowering rates will only keep these d_mn home prices artificially high. Prices need to come down. Why shouldn't renters have a chance to build equity over time in a home (with 4.5% mortgage rates - you'll never build equity, you'll just really be renting again!)
This is actually the wrong way round. The lower your mortgage rate, the faster you build equity in your home, and the less money you waste in interest payments to the bank.
Let's say our friend in Long Island is currently paying $1,000 a month in rent, and would rather spend that $1,000 a month on a mortgage payment instead. If he got a 30-year fixed-rate mortgage at 7%, that would cover a $150,000 loan. Since $1,000 a month for 360 months works out at a total of $360,000 in mortgage repayments, on average about 42 cents of his mortgage-payment dollar will go towards building equity. What's more, most of that is back-ended: after five years, he will have paid down his principal amount outstanding by just $8,820.64, or less than 15% of his total payments.
On the other hand, a $1,000 payment on a 30-year fixed-rate mortgage at 4.5% would cover a $200,000 loan -- which means that 56 cents of every dollar you spend on your mortgage goes towards equity. And after five years, he will have paid down his principal amount outstanding by $17,450.82, which is 29% of his first five years' payments.
So yes, the house is $50,000 more expensive, but it's just as affordable, and you're building up more equity, not less, with the lower mortgage rate.
Of course, there's always the risk that a house bought with a 4.5% mortgage could fall in price more than a house bought when interest rates are higher -- or that the cheaper house has more room for price appreciation. So the calculation isn't really this simple. But if you look at an amortization curve for a high-interest-rate mortgage, it starts off pretty flat: most of your mortgage payments are going to interest. The lower that mortgage rates fall, the more equity you build up in the early years.
All of which is to say: take another look at that rent vs buy calculator. Even at 0% house price appreciation, buying looks much more attractive when mortgage rates plunge, as they have done recently.