Even With Price Drops…Still Paying More?

On Friday, the 10 year U.S. treasury bond yielded 4.01%, the lowest in over two years – a rate last seen in September 2005.  For those who keep abreast of trends in the real estate market, the 10 year bond is an important benchmark and gauge for mortgage financing and rates.  Thirty year fixed mortgage rates typically track the 10 year bond, so when the yield on the 10 year drops, usually so do mortgage rates and vice versa.10-year.jpg

In the aftermath of the credit crisis, mortgage rates are still following the rise and falls of the 10 year yield, but there is a big difference that is making home financing more expensive.  In June, the gap between the 10 year bond and 30 year fixed mortgages have been around 1.5%, meaning that if the 10 year bond was yielding 4.5%, 30 year mortgages could have been predicted to be around 6%.  Now that credit standards have tightened all over, this spread has increased to ~2.2%, meaning that the same 30 year mortgage rate would be 6.7% vs. 6.0%.

Despite the 10 year bond hitting two year lows on Friday, those looking for home financing are not getting the same benefits they would have received prior to the summer credit crunch.  For example, a home buyer taking out a $500,000 mortgage now would be paying an additional ~$230 a month on their mortgage payments thanks to the additional 0.7% increase in rates.

So, even if housing prices are dropping, I think they may need to drop a bit more to really truly compensate for the true cost of home buying.  Expanding further on the example above, if the interest rate was 6.0% and not 6.7%, a home buyer would recive an ~$38,000 more on their total mortgage amount ($538,000 vs. $500,000) by paying the additional ~$230 a month.  Better put, for each $100,000 in mortgage financing, borrowers are getting ~$7600 less but paying the same amount, just because rates have risen.

My take on this is that even though we have seen reductions in home prices, with interest rates being higher than they have been before the summer credit turmoil, the true cost of buying that house hasn’t really dropped all that much or possibly remained flat.  What the home buyer has to shell out each month is either more, or what one can afford to pay per month is getting them less.  Maybe there is some further wiggle room to go with home prices or this could be a great negogiating point for buyers.