Julian and Gabriella (Gabby) are in their early 30s and their careers seem to be doing fine. They own a condo which currently has net equity of about $200,000. They would like to buy a house and, while they have been approved for an $800,000 mortgage, this does not appeal to them. It leaves them too exposed if one should lose their job or get sick (even though they have disability insurance). They would like to be close to downtown and to take public transportation. They often work late so the safety of the neighbourhood is an issue. They would like to buy a house for about $600,000 but houses in that price range are in very short supply. Furthermore, houses whose asking price is around $600,000 are usually looking for multiple offers and a bidding war. Currently, they could get a mortgage loan at 3.5% interest rate per year compounded semi-annually. They think that when interest rates go up (as they must, being extremely low at the present time), housing prices will drop. To explore the possibilities, they are willing to make the following assumptions:
1. interest rates could increase to 4.5% per year compounded semi-annually and then
2. a house that now costs $800,000 would fall to $600,000.
Using a 25-year amortization, monthly payments, and assuming interest rates do not change over the 25 years, what are their total interest costs for the following two scenarios. For both scenarios, assume they would use $200,000 equity from condo towards the down payment for the house. The two scenarios are:
a. The house costs $800,000 and the mortgage loan is at 3.5%
b The house costs $600,000 and the mortgage loan is at 4.5%
If their assumptions are correct, should they buy now or wait?
By how much interest rate goes up that they would be indifferent between buying now and buying later?