Home, Sweet Home

August 8, 2003
The stock market has been, for the most part, in the tank for almost three years now. Yet the real estate market, in general, has held up nicely during that time. Homeowners in many parts of the country have been blessed with rising property values. As a result, many investors are readjusting portfolios to increase their real estate exposure and decrease their stocks and bonds.
Why is the real estate market doing so well while the rest of the economy is struggling? There are many factors involved, but a primary one is mortgage interest rates, which are at their lowest level since the 1960s. According to Jamie Hoggatt, BBA '96, president of Megamerica Mortgage Group Inc. of San Antonio, (at the first of June) interest rates on a 30-year, fixed-rate loan were 5.2 percent, while interest rates on a 10- to 15-year loan were 4.6 percent. "This is the lowest mortgage interest rates have been in the last 40 years," Hoggatt says.
Interest rates are low for several reasons. First, inflation in recent years has been minimal; second, the economy is struggling; and third, there has been an easing of Federal Reserve policy, in part to stimulate the moribund economy. In regard to the real estate market, as interest rates fall, people can afford to borrow more, which means they can afford to pay more, making real estate values rise. The result is that people are buying new and existing homes in record numbers, and there doesn't seem to be anything on the radar screen to lead experts to believe interest rates will rise in the near future.
Furthermore, in addition to a booming real estate market, current homeowners are rushing in droves to refinance their mortgages. To decide if refinancing is the right step, consider a few factors. The rule-of-thumb used to be that interest rates had to drop at least 2 percentage points and the homeowner had to remain in the home for at least two more years before refinancing was feasible. That no longer is the case. Rather, homeowners should view the decision from an investment perspective, i.e., what will it cost to refinance the existing mortgage loan and measure that against the benefits of refinancing. Two major points to consider are that refinancing at a lower interest rate will lower monthly payments, but with rates so low, it also may enable you to reduce the term or remaining years on the loan, thereby saving additional interest.
Consider the following illustration. If you bought a home for $200,000 in January 1998 using a mortgage loan of $160,000 with a 7 percent interest rate for 30 years, your payment would be $1,064.48 per month. Assuming you had made 60 payments on your original loan, you now owe $150,610. If you were to refinance that amount at 6 percent (only a 1 percent difference) for 25 years, your monthly payment would drop to $970.38 per month -- a savings of $94.10.
To decide if the move is financially sound, figure what it would cost to refinance the original mortgage loan. Hoggatt says the industry average is $1,600, so if you invest that amount to refinance and lower your mortgage payment by $94.10, what will your return be? If you stay in the home for at least two more years, the return on that $1,600 investment would be approximately 36 percent per year. That certainly beats the return currently available on money market accounts or certificates of deposit. In fact, you will have recovered your $1,600 investment in only 17 months. Obviously, the greater the interest rate differential, the greater the return on your investment.
There aren't many sure things in finance, but if the numbers remain where they have been recently, there's good reason to consider either purchasing a new or existing home or refinancing your present mortgage.

Dr. Delaney, BA '74, MA '81 and PhD '87 (University of Florida), is associate professor in the Finance, Insurance and Real Estate Department in the Hankamer School of Business.
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