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Mortgage Rates Are All in Your Head

It's like home buyers today are suffering from post-traumatic stress disorder.

The housing crash, foreclosure crisis and banking scandals have all combined to make buyers more sensitive than ever before.

That's why the slightest fluctuation in mortgage interest rates have huge emotional power today.

"I think some people get a little fearful of what the higher payment might mean to them but they don’t' realize how minimal the difference might be," notes Eric Gates, President of Apex Home Loans in Rockville, MD.

In fact, Gates did a little math for me on the change in your monthly payment at different interest rates, if you buy a $200,000 home (just above the national median) with 20 percent down.

  • 4.25%: $787.10
  • 4.5%: $810.70
  • 4.75%: $834.64
  • 5.0%: $858.91

"Keep in mind that difference is mainly interest which is tax deductible. So, someone paying an extra $24 a month in interest who is in a 25% tax bracket is really only paying an extra $18 a month after the tax write off of the extra interest," Gates adds. Yes, cutting the mortgage interest deduction is currently being debated as a deficit-reducer, but the proposal is to reduce the cap from $1 million to $500,000, so it's not going to affect the buyers I'm using as an example here.

The fact is that we're talking less than $100 a month, for a full percentage point increase.

Obviously big cities or in-demand housing markets, where home prices are far higher than the national average, will see bigger jumps in their monthly payments, but if they're able to afford the higher priced home, the change in monthly payment would likely be comparable in its impact on their overall budget.

So why, then, do mortgage purchase applications fall every time rates go up slightly and the opposite when they go down??

The answer is that it is largely emotional. Home buyers seem to ignore what they can afford and focus instead on what they think they somehow deserve in today's badly beaten market.

"Instead of focusing on what's my payment going to be, they see that their friend got 4.25 and they want that same rate and 4.5 isn't 4.25 and they think 'that's not good enough'," says Gates, who has seen that happen more than once. Fear of unemployment also looms large, so buyers are much more careful with monthly payment calculations, even trying to make sure that if they are out of work temporarily they can still make the payments and not go into default.

Questions? Comments? RealtyCheck@cnbc.comAnd follow me on Twitter @Diana_Olick

  • Diana Olick serves as CNBC's real estate correspondent as well as the editor of the Realty Check section on CNBC.com.

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