How much does your interest rate matter?

Liz and I have been looking at buying a home recently (as if having a baby weren't enough stress) so I've had mortgage rates on the brain. We recently got pre-approved for a 4.75% loan, which appears to be just about the lowest rate in recent history. It was up around 6% last November, 9.25% in the summer of 2006, 15% in 1986, and a whopping 18% in late 1981. So how much of a difference does it make to be buying a home now instead of at one of these higher interest rates? Let's take a look.

If we don't count mortgage insurance or any other added fees, we can calculate that a $100,000 loan will look like this at the interest rates mentioned above:

As you can see, borrowing the same amount of money in the early 1980s, you'd have had to pay almost three times as much as you do now. The interest alone would have been over four times the price of the home itself! Now, the interest won't even sum up to the original home price. Of course, homes were cheaper back then, too. So maybe the home that cost $100,000 back then is worth $500,000 now.

The $8000 tax credit for first-time homebuyers (anybody who hasn't owned their primary residence in the past 3 years) is a nice extra incentive, but it's a pittance compared to the lower interest rates.

One more quick comparison before I finish: let's say that you bought a home for $100,000 five years ago and then refinanced it last year for 6%. Let's say you're now wondering whether you should refinance the home, which you've determined would cost you about $5000. You probably haven't paid off much of the principle on the home because the banks purposely weight the payments so you're paying mostly interest for the first several years. Assume that you've still got about $90,000 left on your mortgage and you decide to refinance for $95,000 so that you can get up-front money to pay for the cost of refinancing. Even though it's a 30-year loan, you plan to make extra payments to pay it off in 25 years since that's what you would have done anyway. Here's the difference between just paying off the rest of your $90,000 and refinancing:

So despite adding $5,000 to your loan today, you'd still come out over $13,000 ahead at the end of 25 years!