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February 21, 2024

The Ultimate Showdown: Interest Rates vs Construction Costs – Who's Winning?

Explore how interest rates influence construction and remodeling costs with Murray Lampert's expert analysis. Learn why acting now can save you money on home improvements.

Interest Rate vs Construction Cost Differential

Insights by Murray Lampert Design, Build, Remodel

As a San Diego business since 1975, we have seen interest rates increase and decrease over the years. We understand that the current interest rates cause pause to homeowners who need to undertake construction or remodeling.

At Murray Lampert, we are always looking out for the welfare of our customers, and making sure they are comfortable with their investment is very important to us.

When deciding about major improvements for your home, something to consider is the cost difference in interest when the rates are a few points higher against yearly increased construction cost, which is about 5% in normal times.

For simplicity, we have created an evaluation using an interest-only payment model. Making principal payments is optional and adds variables that confuse the conversation. This article is meant to address how interest rates affect costs in the short and long term.

Homeowner #1 is interested in undertaking home improvements now for $400,000. To fund the work, they have $100,000 in cash and would like to finance the balance of $300,000. They will keep their current low, fixed rate mortgage and get a HELOC at 8.00% (Prime minus 0.5%). The interest expense after the project completion is $2,000 per month.

After 2 years, the Fed starts lowering rates and 5 years later, the rate is 5.00%. This reduces the monthly payment to $1,250 providing the owner now has an opportunity to consolidate to one loan. In 5 years the total paid out in interest is $105,350 and the $300,000 loan must be paid off.

Homeowner #2 decides to wait for lower interest rates before contracting for home improvements once the Fed lowers rates for 2 consecutive quarters, which could be 2.5 years after homeowner #1. Assuming Homeowner #2 is contracting the same scope of work as Homeowner #1, which is now $452,000 using the average rate of construction cost increase of 5% per year. His $100k nest egg is now worth $118,500 and he puts that toward the project, leaving $333,500 to finance. After 5 years, Homeowner 2 has paid a total of $92,588 in interest and owes $333,500.

Homeowner #2 who waited for lower rates, paid less interest than Homeowner #1, but had to borrow more money ($33,500) to complete the project. The net impact is that Homeowner #1 saved over $20,000 by doing the project now and has enjoyed his newly remodeled home for 2.5 years longer than homeowner #2.

Cost Comparison

Homeowner 1

Homeowner 2

Project Cost

$400,000

$452,000

Cash On Hand

$100,000

$118,500

Amount Financed 

$300,000

$333,500

Interest Paid 

$105,350

$92,588

Total Project Cost 

$505,350

$544,588

    • In closing, if you have the need to remodel to improve your quality of living or add space for your growing family, waiting for lower interest rates may not be the best choice. You can realize the benefits of home remodeling or construction much sooner at a lower cost if you start now.

Assumptions:

- $100,000 invested at 7% annual return.

- Prime rate decreases to 5.50%, more “average” historical rate, remains stable

- Interest only payments made on HELOC for 5 years

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