To buy or not to buy..

For those don’t own a house, talking about buying a house is very frequently happening event. I had this discussion about whether to buy a house or not in near future for umpteenth time. This article sees this issue from slightly different point of view.

Note: Skip this section if you already know about adjustable rate and fixed rate. (For computer engineers among us, that is everybody, GOTO LIBOR)

You can get home mortgage for different interest rates. *

1) Adjustable rate: Current Interest rate + 2% (approximately) for X years (usually 3 years) and adjusted based on the interest rates after that.

• Lender has the advantage. After 3 years if the rate goes up he can increase the rate.
• Good to go into this kind of arrangement when the interest rate is high

2) Fixed rate: Current Interest rate + 2% (approx) + premium for X years (X = total mortgage years)

• If rate goes up after few years, Lender will lose and hence he will keep the premium to take care of the losses
  

LIBOR:

Here some of the statistics and assumptions:

Now according to unofficial (means, I heard it from an intelligent friend but did not verify on my own) statistics it is said that 82% of people in Bay area bought their houses using adjustable rate in past 2-3 years.
(Disclaimer: I am as surprised to hear this as you)

Mean prices of houses were ranging from 600-700K in Bay area (not surprised at all)

Given below is the LIBOR** rate or approximate rates that can be used in above calculations for past 6 years.

Year Jan Apr Jul Oct Dec

2005 2.958 3.415 3.924 4.215

2004 1.211 1.368 1.986 2.301 2.775

2003 1.353 1.290 1.151 1.121 1.219

2002 1.989 2.100 1.863 1.618 1.383

2001 5.361 4.231 3.694 2.173 1.983

In past 3 years (especially from 2002 end to mid-2004), the rates are very low.

Most normal buyers, who got adjustable rate, will already be paying at their maximum potential. Best case would be that they have some extra cash that they are saving after paying their home mortgage.

Now that their 3 year fixed rates are coming to end and current interest rates are well above 5-6%. They may have to pay twice or thrice the amount they were paying in the first place. And that may force them to either sell (if they are smart and sees this issue early) or force them into fore-closure (Bank taking their property and selling it).

In either case, if supply is more then prices are bound to come down. And which will its own spiral effect. (Well, one thing that may stall this effect is, if people who have more money keeps buying houses at the rate in which it is sold, then chances of the market staying stable for longer period is there.)

The real effect of these adjustable rates will come into effect starting mid next year and continue for 2 years after that at least.

Conclusion based on this is 2006 end and 2007 beginning would be a good time to buy, if prices come down because above mentioned effect.
(I must say, I felt little guilty about using other people’s bad time to my advantage. But again, this is simple analysis)

Here are some side notes which I could not include in any right places.

1. One of my neighbors bought a house in Pleasanton and he mentioned that he got the house 5K less than advertised price. Though insignificant, it is unusual to hear going below the price. Are we already seeing a cooling down period?
2. For new buyers the increased interest rates will mean extra dollars from their pocket.
3. People who can afford to pay (irrespective of adjustable or fixed) are not affected andgain in long run because of low rate they got.
   
   * This article is not trying to cover the basics of home mortgage and hence it is not accurate with respect to different options available
   
   ** LIBOR is an abbreviation for "London Interbank Offered Rate," and is the interest rate offered by a specific group of London banks for U.S. dollar deposits of a stated maturity. LIBOR is used as a base index for setting rates of some adjustable rate financial instruments, including Adjustable Rate Mortgages (ARMs)and other loans.