What's the significance of the following set?
n = {NULL, NULL, 0.5, 2.6, 4.4, 6.0, 7.5, 8.9, 10.3, 11.6, 12.9, 14.2}
Well, these are APR values that can be fed into the following equation for calculating the monthly payments of a fixed 30-year mortgage.
p = ( c / 100,000 ) * ( x * 100 )
where:
p = monthly payment
c = cost of the mortgage
x = the position within array n[] that matches
the available APR when x = 3 for n[x] = 0.5
For example, the difference between the monthly payment for a $300,000 mortgage at 4.4% versus 6.0% is:
p(4.4) = 3 * (5 * 100) = $1500
p(6.0) = 3 * (6 * 100) = $2000
Or, more precisely:
It costs $500 for every $100k of mortgage when the APR is 4.4% and $600 for every $100k of mortgage when the APR is 6.0%.
Why does this matter? Simple. It means that as APR's decrease, buying power increases. A mortgage of $500k where x=3 (APR of 0.5%) costs the same as a mortgage of $250k where x=6 (APR of 6.0%) which cost the same as a mortgage of $125k where x=12 (APR of 14.2%). And that cost is $1500 per month.
The math lesson is that every time x is cut in half, the market determines that the cost (c) doubles because inflation dictates that payment (p) will approximately stay the same.
The economic lesson is that if you get a mortgage for x=5 (APR of 4.4% (which is realistic in today's economy - because (a) the Federal Reserve is contemplating lowering their lending rate to 0.25% and (b) banks are happy to lend at that rate plus inflation (which is ~4% per year))), you can expect to sell into a market with a higher APR. Thus, when you go to sell, you can expect the value of your house to be worth whatever appreciation can be attributed to inflation times 5/x(future).
Similarly, if you have a mortgage for x=9 (APR of 10.3%) then you can currently sell for the appreciation that can be attributed to inflation since the time of your purchase multiplied by 9/5 (or 1.8). Thus, if you bought 18 years ago for $100k, appreciation dictates that the value would have doubled to $200k and the APR dictates a NPV of $360k. Meanwhile, if you got an ARM loan a few years ago and the prime rate increases to x=9, you just got royally messed up because you won't be able to sell into the market without losing money (because your buyers won't be able to afford a purchase price higher than what you paid).
So what does all this mean? It means respect the 30% rule and don't overextend yourself while purchasing real estate because it's no longer an investment like it was when I was born in 1982. It's just a shelter and a tax shelter. And unless cost (c) actually drops by another 20% renting is probably a better value. This is because the magical "8-12% average rate of return" for real estate since 1983 has been largely attributed to the decreases in APRs. Feel free to check out the historical data and run a few calculations of your own. And considering that the "rate of doubling" for inflation at 4% is 18 years, it's easy to see that the $100k => 360k example is real. Similarly it's easy to see that $400k => 444k after 18 years if the APR jumps from x=5 to x=9. Yikes! 11% over 18 years (not including inflation, the expected inflationary value would be $800k) is a really bad way to spend $2000 a month when you can rent a similar place for $1200 and invest the rest of the money (minus the $600 tax shelter) in something more valuable. Of course, maybe x won't decrease below 5 in 20 years. Maybe it'll stay the same. Bottom line -- it's complicated.
