If you are offered a bottle of water for $2.00 just after breakfast, you will likely say no thanks. Perhaps you’re not that thirsty and you will have time to grab one later. Besides, there is lots of water around.
If a few hours later you are offered a bottle of water for $3.00, you are likely to say not a chance, even though you are now a bit thirsty, pressed for time, and nowhere near a store or tap.
Principle enters the picture at this point. You could have had the bottle for $2.00 just a few hours earlier. As we get into late afternoon, having worked through lunch, you finally cave in and say yes you will buy the water, but of course now it is $4.00. What?!?!?
This is the crossroads. You either dig in with that $2.00 price stuck in your head, and no damn way do you pay double, after all this is crazy, the increases are unsustainable, and clearly people have lost their minds… or you find acceptance that not only do you need water, but clearly it may well be $5.00 by tonight.
Applied to our real estate market, more people are accepting the new reality and buying than are not. The record sales stats each month make that clear.
The Numbers (Don’t confuse me with your logic.)
Part of the rise in prices – not nearly all of it, but part of it – can certainly be traced back to falling interest rates.
Odds are if you think today’s market is crazy-town, then you probably took your first mortgage out at 6% or higher, and indeed those payments would have been tougher to make had the home been 50% more expensive. One needs to look at the ratio between purchase price and payments to get a firmer grasp on how these higher prices can be tolerated.
- $200,000 @ 12% $2,063.80 per month
- $320,000 @ 6% $2,047.38 per month
- $450,000 @ 2.49% $2,013.61 per month
*all calculated at 25 year amortizations.
As you can see, if you are financing 95% of the purchase price of a home, it actually costs you less with each price hike if the cost of borrowing to buy it drops at the same time.
It is less about the purchase price than the payment. At all three purchase prices the payment is pretty much the same.
So yes, the price of that bottle of water went up, and that is hard to um…swallow. But it goes down a little more easily when the monthly cost is so similar. We humans are far better with short term math than long term math.
Which is why we look more at the monthly payment than we do at the overall purchase price.
It is not about what is costs, as much as it is about whether we can afford the monthly (or better yet, bi-weekly) payments.