I have shocking news for you: The higher the interest rate on your mortgage, the less advantageous it is to buy a house. After you have digested this shockingly new information, let’s see the actual effect of the increasing mortgage interest rate.
Our starting point is still the sample property of Part 1. There we saw that after living in the house for about 6 years, our situation will be more advantageous comparing to renting a similar property for the same time. What will happen if we change the interest rate from 2.4% to 3.4% while keeping all the rest of the factors unchanged?
As expected, the break even point has moved further to the right on the X axis. Now we would need to own the same property roughly a year longer. At the same time, afterwards the spread rapidly gets bigger, in the favor of home owning.
What if we move towards a bit more extreme values. Let’s change the interest rate to 8%. Our chart will look like this:
You can see that our blue (buy) line is nowhere close to the red (rent) one. Is renting the clear winner under this scenario? Looks like, but let’s stop for a while. Remember from Part 1 that one of our variable is the inflation, which we set to 2%. There is no formula to calculate a rough mortgage interest rate based on inflation, but via several factors they are more or less connected. So let’s just accept that it is highly unlikely that you’ll be in a situation when you get a 8% mortgage while the inflation is only 2%. It would be more like around 6%, in which case our chart would look like this (we will cover the inflation effect in more detail in a future post):
Looks a bit better. Anyway, back to the previous thought, while you might not have a situation when you get 8% mortgage interest while the inflation is 2%, you might be in a situation (most likely not in the next few years) when you have an 8% mortgage, while the inflation would go back from around 6% to 2%. In such situation the interest rates would probably also move lower, so you’d be better off refinancing. Of course this would come with additional costs (depending on the specific mortgage they could be quite high). The point is that solely based on the mortgage interest rates, in practice you will not find such a situation when renting would be much more beneficial on a long term.
Finally, linking this extreme example back to our previous topic of price to rent ratio, let’s see what happens if we change the ratio from 18 to 15, while keeping the 8% mortgage interest and 2% inflation (which based on the above it would be really an extreme).
Just over 6 years buying wins again! If you’re lucky enough to live in an area where the price to rent ratio is low enough and you’re willing to live there for a couple of years, the decision between buying and renting looks easy for me.
Based on the above examples, the mortgage interest rate seems to be a factor that could move your break even point back or forward a few years. It is important, but surely not as important as the price to rent ratio. Nevertheless once you already have a mortgage, I would definitely review the conditions every now and then to see whether refinancing would be beneficial.
Do you agree with the above, or have different opinion? Maybe some thoughts to add? Feel free to comment below!
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