You already know that home prices have dropped a lot in the past few years. If you’re looking to buy a home, should you act now or wait and hope for prices to go lower. I can’t give you personal advice through this blog, but I will tell you this: buying a home right now is cheaper than you think.

According to the most recent data release for the S&P/Case-Shiller Home Price Indices, the price of the average house in the Minneapolis area has dropped about 35% from the peak (your local area may have had a larger or smaller drop). That certainly is a large decline and sympathy is deserved for those non-speculator homeowners who have had to sell at such reduced prices.

If you’re a potential buyer, of course, a 35% price drop should be seen as an opportunity to make a good purchase. But there’s one more aspect of the current housing market that makes it even better: home mortgage interest rates are at generational lows. So not only have the nominal prices of homes dropped, but the real cost of ownership has dropped even more.

Freddie Mac reports historical 30-year fixed mortgage rates on its website. Five years ago, in August 2006, the average 30-year mortgage interest rate was 6.52% while paying 0.4% of the loan value at origination. Now, in August 2011, the average rate was just 4.27% while paying 0.7% at origination. So how much is that worth to you?

Let’s do a scenario analysis to find out. Assume that you are interested in buying a house that was valued at $300,000 five years ago. Figuring in a 35% decline in value, you might be able to purchase that house for $195,000 today. To get the best mortgage rates, you would make a down payment of 20. Let’s compare these two loans as if mortgage rates had not changed to see what your monthly payments are.

     Assumes 35% home price drop but NO change in mortgage interest rates:

So what would have been a $1,526 monthly payment five years ago is now only $992. That is a 35% reduction, matching the drop in the home’s price.

Let’s take the next step and adjust for the fact that today’s mortgage rates are much lower (while the points are slightly higher).

      Assumes 35% home price drop AND drop in mortgage interest rates:

The monthly payment on the August 2011 purchase dropped from $992 to just $775 after accounting for current interest rates. Compared to the $1,526 monthly payment in August 2006, $775 is just 51%. That house is truly half-priced! Also note that you have to save much less for the down payment which means you save even more money and it takes less time for you to build up the cash.

The lesson here is that houses are quite affordable given the drop in both price and financing cost. So if you’re a prospective buyer trying to time the bottom of the market, I have two questions for you. One, which market are you trying to time, housing prices or mortgage rates? They probably won’t bottom at the same time, so the odds of successfully calling THE bottom in the true cost of ownership are quite low.

The second question is, if your cost to own has already been cut in half, is there more risk to you on the downside (overpaying compared to the absolute bottom price) or the upside (acting too late before either prices or mortgage rates swing higher)? Think about a retailer’s liquidation sale. They may start with relatively small markdowns, say 15%, and continue to increase it over time. Maybe around the 30-40% markdown, you can still get quality products and a good value. But if you hold out until the final 75% clearance sale, you’ll find a lot of really cheap products, but all of the good stuff is long gone. Sometimes, it doesn’t pay to wait for lower prices.


* Please note: All assumptions and calculations made above are hypothetical and assume that you can afford to make a 20% down payment and qualify for the best mortgage rates. Mortgage rates vary depending on location and fluctuate over time, which will potentially increase the monthly payment. Actual home mortgage loans generally contain additional fees beyond points, which increases the total loan size and monthly payment. The impact of tax deductions for mortgage interest paid were not considered in this analysis.