In the last six months, lumber prices have drastically increased. By drastically, we are talking by more the double the price they were at in March. This has driven the price of a house up sharply as we approach the end of the year. But we have also seen, historically, the lowest interest rates for a home mortgage. We are talking near record lows for a home mortgage. Most home buyers take out a 30-year loan to finance their home. So now we have what is called a quandary (i.e., a state of perplexity or uncertainty over what to do in a difficult situation). Do you wait for lumber prices, and therefore home prices to come down (which they may not), or do you miss the opportunity now to get the lowest interest rate on your home mortgage ever before interest rates rise (which we know they will)? Let’s layout the situation.
What is Happening with Lumber Prices?
When the coronavirus started initially, demand for lumber slumped. The lumber mills reacted by cutting production as demand died. But, with everyone “working from home,” the demand came back with a vengeance. Home Depot and Lowe’s couldn’t keep up as everyone started doing home projects and building decks, etc. In addition, home demand, which was strong before the pandemic, has increased at a dizzying pace. As the mills tried to increase production, coronavirus outbreaks in their workforce have kept many from reaching full production. Once you add in the Canadian lumber tariffs, the cost of lumber has nowhere to go but up.
But what happens next? In the building industry, most suppliers implement price increases in late winter or early spring. As the lumbers surcharges (which are typically temporary) carry on longer into late winter or spring, the fear is that suppliers will just make the surcharges permanent and make them next year’s price increases. That makes these temporary price increases permanent. What this means to the new home buyer that is building their home is that this “temporary” increase in home prices wont’ be temporary. It could become the new base price for building a home. But now the good news!
What is Happening with Interest Rates?
Around the world, interest rates are the lowest in human history. And everyone wants to know what will happen next. Historically, home mortgage interest rates tend to be stable leading up to a presidential election. Once the election is over, then where they go is anyone’s guess. At the writing of this article, the average interest on a 30 year fixed mortgage loan is at 3.08%. In May of 2019, the average interest rate on a 30 year fixed mortgage loan was 4.07%. While historically speaking, 4.07% is a fantastic interest rate, that 1% is significant. A home is the largest investment most people will make. That also makes it likely to be the biggest thing a person will finance.
With rates currently being at historic lows and the election coming up in November, that probably means that interest rates have nowhere to go but up. Then the question becomes, “How far up is up?” If we go back to 2018, the annual average 30-year mortgage rate was almost 5%. Let’s layout several scenarios to help in deciding what some likely outcomes could be for home buyers building a home in the coming months.
The Impacts on You
Compound interest can be your best friend if you are earning it, such as putting your money in a savings account or a Certificate of Deposit (CD). Compound interest can also be your worst enemy when you are paying it, as with a credit card balance or a home mortgage. This is because you aren’t just paying interest on account balance; you may be paying interest on the interest that is accumulating on your account. That’s why even small changes in your mortgage interest rate can have deceptively large impacts on your payment and account balance. Here are a few scenarios to look at:
Let’s say you want to build a beautiful new dream home today, even with the current lumber prices, and after your down payment that the mortgage loan you are going to get is $275,000. We are at historically low rates, so you are going to finance that at 3.08%. So your payment would be $1,171 (with a total mortgage cost of $421,672). Note: we will only be displaying Principle and Interest amounts or PI only for this discussion. (Scenario #1)
But what if you wait until spring to build, prices stay the same, and interest rates on that same $275,000 mortgage go up to 4.07% (the rate from May 2019)? The payment on this mortgage would be $1,324 (with a total mortgage cost of $476,645). That means your monthly payment went up $153 per month for the exact same house you could have purchased six months before. (Scenario #2)
RELATED: What is Your Home Purchasing Power?
Now, what if the price of the house comes down to $260,000 after surcharges and prices increases are accounted for in the spring and your interest rate still goes up to 4.07%. Your new monthly payment is now $1,252 (with a total mortgage cost of $450,646). That means you waited to build, and now you are paying $81 extra every month. That is $972 extra on a mortgage every year because of the delay in building your new dream home. (Scenario #3)
To be fair, let’s say interest rates only go up to 3.55% in the spring, AND lumber prices come down somewhat, so your new home price is at $260,000 instead of $275,000. Your monthly payment for this loan will be $1,175 (with a total mortgage cost of $422,923). That means you are still paying $4 per month more to get the exact same house you could have gotten today at a price that was $15,000 more! That is the power of compound interest! (Scenario #4)
|Payment Comparison Summary|
|Scenario #1||Scenario #2||Scenario #3||Scenario #4|
|Payment (PI Only)||$1,171||$1,324||$1,252||$1,175|
|Total Paid – Life of Loan||$421,672||$476,645||$450,646||$422,923|
What is the Right Decision for You?
If you had a crystal ball, you wouldn’t have to guess at the right answer. But since you most likely don’t have one, all you can do is make the best decision with the information you have. We typically use the past to predict the future. We know that the average annual mortgage rate in 2019 was 3.94%. We know that the average annual mortgage rate in 2018 was 4.54%. Again, when something is the lowest it has ever been, the only place to go is up. That means historically speaking; you can count on interest rates to increase… but by how much? A half of a percent… one percent… one and a half percent?
Will lumber prices continue at their current highs? Probably not, but how much will the price of a house come down? Most likely not as much as they have recently gone up. Homebuilding industry suppliers implement their annual price increases at the beginning of the year. That means you have to make an educated guess on where prices will land.
The most likely scenario is that if you are going to have a mortgage, then you are better off to build now. Waiting means risk. Risk that interest rates will go back up to 2019 or 2018 rates in the new year. Compound interest means that paying more for your home today is better than paying a higher interest rate next year, even if the actual home will cost you a little less.
Modular Construction Gives You the Best Value in Home Building
When you decide it is time to build your new home and you know you will need to finance it, don’t wait. The very first place you should go is to a construction loan lender and get pre-qualified for a loan. It is important to know if you qualify and how much you qualify for when you start the actual search for your new home plan.
A home built using modular construction is treated just like a home built on site for conventional 30 year or 15-year mortgages. Because your home is built using modular construction, more is completed off-site. Factory efficiencies mean modular homes are built at a better value, with better quality, and with the ability to build using almost any design style. Modular means more!
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