A Bird’s Eye View
In price vs. interest: Which should you choose?
Today I want to ask a question that challenges your thoughts and opens your options to looking at real estate on different levels, not just the first one that comes to mind: price.
Price is often the factor of a good or great deal, but is nevertheless an often-misunderstood focal point of the purchase.
Although price is important, unless you are paying cash, price should not be used as a singular argument but rather as an honest attempt to negotiate the best market value for an investment.
Yet so many other important and overlooked items are never accounted for, or quantified, in the purchase as a monetary value to the transaction.
So here is the question. Which would you prefer: a 10% decrease in the sales price, or a 1% decrease in the interest rate on financing?
I have asked this question in offices all over Southern California, and the first answers are always a 10% reduction in price, given that the amount is generally greater and the down payment is less.
Using a $500,000 purchase, I will explain the details of this question and refer to the comment that money is money regardless of the place it is saved or paid.
Assuming a purchase price of $500,000 and a down payment of 20%, we will analyze this purchase at a 5.5% interest rate.
And for those who have higher prices or lower prices, you can calculate the outcome by dividing or multiplying the amounts and finding the denominator of your transaction. In other words, if it’s a $1 million purchase, multiply by 2, and if it’s a $300,000 purchase, deduct 40% from $500,000.
A purchase price of $500,000 with a down payment of 20% ($100,000) leaves a financing value of 
$400,000. If the rate is 5.5% amortized over 30 years, the monthly payment would be $2,271.16.
Therefore, which would you prefer: a 10% reduction in price or 1% reduction in rate?
Let’s look at some of the issues to help you better answer the question.
1) A reduction in price would provide the following relief; the purchase price would be $450,000 at 20% down, or $90,000, that equals a financing value of $360,000 at 5.5% amortized over 30 years equals a monthly payment of $2,044.04 a month. Interest-only financing at 5.5% would be $1,650 per month.
2) A reduction in interest would provide the following relief; a purchase price would be $500,000 at 20% down or $100,000 equals a financing value of $400,000 at 4.5% amortized over 30 years equals for $2,026.74 a month. Interest-only financing at 4.5% would be $1,500 per month.
Therefore, which is better, given the matrix we established?
The savings on the discounted example is unrealized in the purchase unless paid for in cash. The down payment is reduced by $10,000 dollars but the payment is increased monthly by $18.70 over the amortized loan, or an estimated $46,228 of interest paid over 30 years (almost all of the discounted savings).
But why is the payment lower on the adjusted-interest example? Because the overall payment of $2,044.04 amortized over 30 years pays more to interest and less to principal. Therefore, the lower interest rate (4.5%) is the better selection.
Conclusion: Your proposed savings is paid in interest (5.5%) over the same period (30 years), given a lower price transaction ($450,000), whereas a lower payment and higher principal reduction is realized in the lower interest rate (4.5%) example.
Assuming interest-only financing is applied (higher payment on the discounted example), the cost in the discounted example ($150 per month higher) would be $9,000 over five years, $12,600 over seven years, and $18,000 over 10 years — almost all of and more of the down payment savings of the discounted price in a payment. Given these parameters, and the public being payment-driven, I expect the better selection would be a non-discounted purchase at a lower interest rate.
Ultimate win-win situation: Always negotiate, given your agent’s recommendations, the list price to the best value, and always seek a buy-down reduction in the interest rate to maximize both savings.
Most lenders have this option available, but the cost to reduce the interest may vary depending on the amount of buy-down (1/8% to 1%) and the loan product you select. This is the best of all worlds in a transaction where financing is a contingency. Not only does it lower the payment, it assists in the buyer’s qualification process, making the purchase a lower risk for final release of contingencies and approval.
Some may argue that the lower-negotiated price realizes a lower tax rate or savings of $625 annually on the example. Yes, that is true, but in deflationary times, which are recurring in real estate, you can negotiate your tax base lower through the county tax assessor.
But unless you refinance your loan, which can be costly in points, appraisal, escrow and title fees, and therefore further undermine any discounts you may believe you negotiated, your interest rate remains constant or fluctuating predicated on your loan terms.
It raises a concern, and leads to prove that consumers place more value on price, in some cases the talk of the dinner table among friends that leads to the discussion comparing a good deal too a great deal, but nevertheless does not determine a great savings or smart decision given the market conditions.
BUYER CONFIDENCE IN 2011
On another note: How’s the real estate market doing so far in January 2011? Optimism is evident but the media can sway the flock anytime. So far, for those who follow our national trends, the stock market and Fed
See VIEW, page C32
