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The Cost/Benefit of Giving Up a Low Mortgage Rate For a New House

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A reader asks:

I have a low interest rate (2.75%) house that I refinanced a year ago. My family is growing (we have 3 kids) and it may be time to buy a bigger house. may earn interest). Is there anything I can do with this low-interest asset? Or do I have to sell the house for 2.75% and raise the money at a higher interest rate? How much do you value that rate change (assuming both houses are $500,000)? Is there a way to calculate that?

This is a choice that millions of homeowners will face in the future.

Mortgage rates could drop significantly during the next recession, but that’s not a foregone conclusion.

What if mortgage rates of under 3% during the pandemic were a historical anomaly?

It is certainly possible.

Even interest rates in the 3-5% range are low by historical standards.

Mortgage interest rates have been above 7% almost 60% of the time since 1971. The high interest rates of the 70’s, 80’s and 90’s may have been an anomaly, but the past few years seem to have been an outlier.

I did the same exercise when my twins were born, but it became clear that our house couldn’t handle three children.1

Mortgage rates were close to 4% at the time (2017), but house prices were much lower, making the decision easier.

I wish I had better news, but if I have to move, I’m out of luck when it comes to mortgage rates.

It’s understandable why homeowners are reluctant to give up that outrageous mortgage rate.

If the fixed rate is 3% or less, you are currently borrowing at a lower rate than the federal government.

Yields are over 3% for 6-month, 12-month, 2-year, 5-year and 30-year Treasuries. It’s been close to 10 years.

The most painful part of the trade-up is obviously the high monthly payment.

Let’s say you have a $500,000 home with a 20% down payment.

At 2.75%, that’s a monthly payment of just over $1,630 per month.

If you look at the same house with a mortgage rate of 5.75%, your monthly payments are over $2,330.

This is an additional charge of $700/month ($8,400/year). And we’re not even arguing with the fact that larger homes today arguably cost more money (which means they also have higher taxes and maintenance costs).

Not many good options:

  • You can just suck it up and buy a bigger house. Higher monthly payments and higher interest rates are worrisome, but if interest rates drop in the next recession, you may be able to refinance in the next few years. There’s no guarantee that 2.75% will show up again, but you never know. It’s rolling the dice.
  • You can renovate your current home. Most homeowners now have a sizeable amount of home equity. Not cheap, but you might be able to add a bedroom. Or you can let your kids smoke it and sleep on the bunk bed. Believe it or not, many families at the time had her five or six children in a two- or three-bedroom home. I guess it depends on how many rooms you want.
  • You can also consider other forms of funding. A few months ago I could have gotten a lower interest rate on a variable rate mortgage, I confirmed it today and they actually taller than Lower than 30-year fixed rate (5.7% vs 5.5%). You can try fixed for 15 years, but now he’s around 4.8%. Alternatively, you can use your current home equity to deposit more money.

Unfortunately, all of these options lead to higher costs in one way or another.

This question shows why homes are the most emotional of all financial assets and no second closest.

The spreadsheet tells us to stick with that juicy 2.75% mortgage rate. This is the best inflation hedge possible and could result in the lowest mortgage rate of your lifetime.

But financial decisions don’t exactly exist in Microsoft Excel.

Decisions of this kind must be qualitative. Housing provides a spiritual source of income you won’t find it anywhere else.

Is it worth finding a new home for your family?

Do the benefits of trading up the scale outweigh the costs of trading up the borrowing rate?

I’m not going to sugarcoat it — losing that sub-3% mortgage rate is going to be a pain.

But sometimes we have to make painful financial decisions for the sake of our family and overall well-being.

We covered this question in this week’s Portfolio Rescue.

Barry Litholtz I revisited Manhattan real estate questions, helped my grandmother with her portfolio, and used HELOC to buy stocks.

Here’s the podcast version of this week’s show:

1In fact, twins were born in May and moved to a new house in June.The Carlsons were a little busy that year.

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