I happen to think prices are bottoming out this Summer, and have said so since February (I would only exclude the worst offenders in subprime which additionally have high unemployment, places like the Inland Empire and Las Vegas).

However most people think even with sales picking up prices have more to fall.  So let’s say I’m wrong and prices do fall another 10% into next year.

Even then this is the best time to buy.  Why?  Because mortgage rates are going up and will be way higher this time next year.  About 3 points higher.

Mortgage rates will be up sharply because U.S. treasuries are shooting up (there is, of course, a strong direct correlation between treasury yields and 30-year fixed mortgage rates).  This is not due to inflation fears, or ‘China dumping our treasuries’ or some other ominous headline, but simply because:

a) The economy will continue to improve, and there will be a massive flight away from safety into higher yield asset classes.  People, funds and companies selling their treasuries and putting their dollars into stocks, commodities, hedge funds or Silicon Valley venture funds means treasury prices will go down, and yields up.

b) The Fed will start ratcheting the funds rate up by late 2010 to mop up the massive excess liquidity and keep inflation in check.

So let’s run the numbers using this calculator.

For a $500,000 house, with $100,000 down, at the current 5.5% rate on a 30-year fixed (1.25% tax and 0.5 PMI):

Monthly payment: $2854.49

Total interest paid: $440116.16

Now let’s look at the same house, one year later, now priced at $450,000 with a $90,000 down payment, and an interest rate of 8.48% (corresponding to a 7% treasury yield per this):

Monthly payment: $3,287.99

Total interest paid: $654,925.49

Even though the down payment was $10,000 less and therefore easier to ‘get in the house’, the increase in monthly payment is $433, for 30 years! which comes out to $214,809.33 in additional total interest.  So, again, house price was $50,000 less, and yet payments will be $433 more.

Of course, if prices do stabilize, monthly payments will be even higher ($799).

Some caveats:

  • If prices do go down 10% you will lose half of your equity in the near term (50K of the 100K down payment), so this only makes sense if buying for the long term.  But really, is anyone still planning on flipping a house?
  • A higher mortgage rate and corresponding monthly payment is not so bad if you’re able to refinance after some years.  But rates are near all-time lows, so they probably won’t come back down anywhere near this for another couple decades, if ever.

So, am I missing something?