When it comes to buying and owning a house, two key variables impact how much you spend on your mortgage: home prices and interest rates. While house prices are the more obvious factor determining how much you pay over the life of your loan, interest rates also play a crucial role in the total cost of your mortgage.
This leads to an essential question for home buyers: Is it better to buy a less expensive house with a higher interest rate or a more expensive house with a lower interest rate? Let’s walk through the math and your options so you can navigate your next home purchase with a greater sense of financial confidence.
Read more: How to get the lowest mortgage rates
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Deciding whether to prioritize a low home price or mortgage interest rate is more than just a simple mathematical question. That’s because there tends to be an inverse correlation between home prices and interest rates in the housing market. Specifically, home prices tend to be lower when interest rates are higher, and home prices typically go up when interest rates are low.
This relationship involves the economic principle of supply and demand. In this case, interest rates can affect the demand for homes in the housing market. Lower interest rates generally mean increased demand for houses, leading to home sellers setting higher home prices. On the other hand, higher interest rates can reduce the demand for homes, so home sellers lower their prices to entice potential buyers, and home values decline.
What’s so interesting about the current housing market is that we’ve seen high interest rates and high home prices — not to mention some economic uncertainty regarding the economy and inflation. So, it’s worth noting that every financial rule has its exceptions, as we’re currently living in a time where the exception has become the rule.
Learn more: When will housing prices drop?
Calculating a home’s affordability depends on three things: your down payment, monthly mortgage payment, and lifetime cost of the home loan.
Conventional loans require a down payment. If you want to avoid paying private mortgage insurance (PMI) you’ll need to put down at least 20%, though some mortgage lenders may accept as little as 3% down. As of 2024, the median down payment on a house in the U.S. was 18%, according to the National Association of Realtors (NAR).
If you purchase a home at a lower price but a higher interest rate, your down payment will likely become more affordable. For example, say you purchase a $220,000 home while interest rates are high. You can put down a 20% down payment, or $44,000, and get a 30-year fixed-rate mortgage with a 6.75% interest rate.
But if you waited for interest rates to fall before buying a home, the same house may sell for $300,000. Although 30-year mortgages could have lower interest rates, you would now need $60,000 to make a 20% down payment and avoid PMI.
Learn more: How much house can I afford? Use Yahoo Finance’s home affordability calculator.
Your monthly mortgage payment depends on several factors, including how much you borrow and the interest rate on your loan. For a $220,000 home purchase with a $44,000 (20%) down payment and a 6.75% interest rate, your monthly payment toward the mortgage principal and interest will be approximately $1,142.
If you wait until rates fall to 5.75% and purchase the home for $300,000, you must find another $16,000 to make a 20% down payment of $60,000. If you can afford the higher down payment, your monthly mortgage will be approximately $1,400 — a little over $250 more per month than if you’d purchased the home at a lower price and higher interest rate.
However, say that a $60,000 down payment is a bit out of reach. If you buy the home at $300,000 with a $44,000 down payment, you will be on the hook for PMI until you’ve built up at least 20% equity in the home. If you pay 0.5% in PMI annually, your monthly mortgage payments toward the principal, interest, and PMI will be approximately $1,619 for the first 52 months. At that point, you will have built up 20% equity, and you can apply to drop your PMI. Then, your monthly payment will drop to $1,494 for the life of the loan. In this case, waiting until the rates decrease will result in a monthly payment that’s $352 to $476 than if you had bought the less expensive house at a higher interest rate.
Note: These monthly mortgage payments do not include homeowners insurance, property tax, or homeowner’s association (HOA) dues. To get even more accurate numbers, use Yahoo Finance’s mortgage calculator.
Interest rates, home price, down payment, PMI — all these individual factors that add up to the total cost of owning your home.
Let’s look at the three examples we’ve been discussing:
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$220,000 house with a 6.75% rate and 20% down payment ($44,000)
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$300,000 house with a 5.75% rate and 20% down payment ($60,000)
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$300,000 house with a 5.75% rate and 14.7% down payment ($44,000)
In this case, buying the less expensive home with the higher interest rate saves you money on your down payment, PMI, monthly mortgage payments, and total cost. But keep in mind that the numbers will depend on your exact interest rate and house price. The lower house price won’t always beat the lower rate, especially if you don’t have a 20% down payment in either scenario.
Learn more: How much does private mortgage insurance (PMI) cost?
Interest rates can affect housing prices in some cases. When interest rates are low, more people can potentially afford to buy a home. Therefore, housing prices might increase as sellers have the upper hand since more buyers are in the market. On the other hand, high interest rates can make people hesitant to buy a home. In this case, housing prices might drop since fewer buyers are in the market.
Buying a home when interest rates are high can make sense if the down payment, closing costs, and mortgage payment are affordable. If you have the luxury of waiting to buy, however, you may come out ahead financially by waiting for interest rates and/or home prices to come down — especially if you use this time to save for a higher down payment or otherwise improve your finances. Timing the real estate market is tough, even for the pros, so your best bet is working with licensed real estate and mortgage professionals who can help you run different scenarios and find a home and mortgage that fits your budget and goals.
If you have an adjustable-rate mortgage (ARM), then yes — your mortgage payment could go down at the next adjustment period after a rate drop. Your mortgage can also increase if rates go up with an ARM. However, rate hikes and drops won’t impact your monthly payment if you have a fixed-rate mortgage.
This article was edited by Laura Grace Tarpley.
