Mortgage Rates Beat Tax-Credit Benefits

Mortgage rates beat tax-credit benefits
By Aldo Syaldi ~ August 25, 2010

Homebuyers today can potentially save several times more money in interest costs than buyers who took out a mortgage in early April and claimed an $8,000 homebuyer tax credit.

Yet buyers, who rushed to meet the April 30 deadline for the federal tax credits, appear much less eager to borrow at the lowest interest rates in 60 years.

Mortgage applications for home purchases are 42 percent below the pace seen in April, according to the Mortgage Bankers Association. Home resales dropped 27.2 percent in July from June, according to a report Tuesday from the National Association of Realtors.

Someone taking out a $240,000 mortgage today at a 4.42 percent interest rate could save $33,287 in interest costs over the life of a 30-year loan. That's four times the $8,000 credit used by a first-time homebuyer who financed at 5.21 percent in early April.

So why aren't more people buying now?

Timing offers one explanation. Buyers earlier this year, not knowing rates would drop, took the best deal available to them at the time.

That soaked up future demand, which more optimistic forecasts hold should return as lower rates persuade buyers to get off the fence.

Because few people stay in a home or keep a mortgage for 30 years, the time needed for monthly mortgage savings to match the $8,000 credit is another consideration, said Cameron Findlay, chief economist of LendingTree.com.

On a $240,000 mortgage, a buyer would need to stay put for almost six years for monthly mortgage-payment savings to match the upfront credit.

Studies in behavioral finance support the idea that people will go for a payout upfront versus a payout spread over a long period that is worth more.

Uncertainty leads to stagnation Given the choice between a 10-percent pay raise when inflation is 12 percent or a 4-percent raise when inflation is 2-percent, respondents almost always go for the bigger raise, even though it means they will lose ground, said Greg Salsbury, an executive vice president with Jackson National Life Distributors in Denver.

Rather than seizing opportunities, many people also tend to freeze up when there is too much uncertainty.

"Unemployment, the deficit and the overall economy are impacting people's decisions disproportionately," Salsbury said. "There are a lot of things in play."

Some mortgage brokers and bankers argue against complicated explanations about why buyers are missing in action.

"The majority of my borrowers used the $8,000 tax credit toward the down payment, and the Seller paid closing costs," said Marilyn McConnell, a mortgage adviser with Cherry Creek Mortgage.

Lower interest rates don't help those buyers who can't come up with the needed down payment or who are trapped in a home they can't sell without taking a loss.

Deflationary expectations Selling at a loss is psychologically hard, even if you realize the lower payment on the next property will make up for it over time, said Denver resident Shanti Klemm.

"We'd love to buy a new home, but we have to sell first. It's a Catch-22," said Klemm, who estimates her family will lose $25,000 by selling its condo.

Another more worrisome explanation is that consumers expect further declines in interest rates or home prices. A survey from real-estate website Zillow.com found that a third of homeowners thought home values in their area had more room to fall. If prices are headed lower, the rational thing to do is to wait for the better bargain. But deflationary expectations, like inflationary ones, become self-reinforcing. During the housing boom, people bought homes because they worried that prices would rise the longer they waited. Flip that around, and people may now be waiting to buy because they expect prices to go lower.

Realtors see how many incredible deals are out there, and, with interest rates being so low say it's a ripe time to buy.