Is It A Good Time to Buy a House When Interest Rates Are Low?

I have a discussion with a friend of mine on whether it is better to buy a house when interest rates are low, as they are today, or high. I think the recent real estate collapse provides the answer.

The conventional wisdom is that the best time to purchase a house or real estate is when rates are low. We've all heard the saying, "when rates are low you can afford more house." And this is true. When rates are low, buyers can afford more because monthly payments are lower. But the reality is, everyone can afford to pay more and as a result home prices rise for everyone. During the most recent real estate bubble, rock bottom interest rates and lax lending standards combined to create a sellers market. Money was cheap. As a result, home prices soared.

Now, let's look at purchasing a house in a high interest environment. When rates are high, home prices are lower. Like a bond, home prices move inversely to interest rates. So while you may pay a higher rate, you're able to buy the same home because prices are lower.

So is it a wash? Not really. That's because if you purchase a home in a high interest rate environment, you can always refinance your mortgage at some later point when mortgage rates fall. And they will fall at some point because mortgages, like anything else, are cyclical. But if you purchase a home in a low interest environment and mortgage rates rise, then the value of your home drops, your equity disappears and depending on how much equity you have in the house you might be underwater.

The low interest rate scenario is exactly what has happened to millions of people across the country. They purchased a home during the low rate, easy money era between 2001-2005. As banks began to tighten in 2006 and rates began to inch up, the real estate market collapsed. Now, the Fed is trying to reinvigorate real estate by driving rates down again. But because banks are not lending and consumers are worried about jobs, no matter how low rates go they won't be low enough to prop up home prices.

If you're thinking of buying a home in this low-rate environment be careful. Because you most likely will never be able to profitably refinance and chances are, your home's value will go down if mortgage rates go up.