Interest rates are becoming a hot topic lately. With interest rates shooting up approximately 1% in about a month, there is plenty to talk about. It seems that some people were only in the housing market as a result of give away mortgage rates. When I hear someone exclaim surprise when I quote a 4.5% interest rate, because they heard rates were at 3.5% six months ago, it actually shocks me that people are surprised. It is as if most people expected rates to stay down forever. Any casual student of interest rates and general economics knows that interest rates, as with any market, move up and down constantly.
I would argue that we have had very, very low interest rates for far longer than a normal market may have kept them low, thanks to intervention by the Federal Reserve. So an increase was inevitable, but people’s surprise at the increase, well, it surprises me!
So now when people tell me that interest rates are too high, I go searching for an answer that won’t offend them. A good analogy might be if the car manufacturer Mercedes decided to sell $50,000 cars at $30,000 due to a major car buying slump, but after a long period of offering those discounts they were able to raise prices back to normal, would the world stop buying $50,000 Mercedes? Would the logic be that the consumer had gotten used to $30,000 Mercedes cars so now they don’t feel the car is worth $50,000 any longer? Of course that would be an emotional answer, not a rational one. A car is worth what the marketplace says it is, so if Mercedes can command $50,000 again after a slow period of charging $30,000; then the people complaining that the Mercedes car is not worth $50,000 were probably never really Mercedes buyers in the first place.
In other words, as rates dropped we were gaining, and now that rates popped up we are losing. But since we have only lost what we gained, aren’t things even? We are really still ahead of the game, because we are far from historically average rates, in fact, we are still almost 2% away from average. So to me, we are still in positive territory!
This brings me to a question of my own about interest rates. If rates rise 1%, where and how does that affect housing prices? If some potential homebuyers pull out of the marketplace, that will affect supply and demand. Some potential homebuyers that still stay in the marketplace may decide that the $700,000 house they were looking at is now no longer worth $700,000 to them in light of current rates being a lot higher. So do buyers start to offer less, or at least stop being so aggressive in their offers in offering above the asking price, which they were forced to do in light of competition and low inventory? Do sellers start to see the shift in buyer demand, and then more sellers will put houses on the market that they had maybe planned to hold off on in light of increasing real estate prices over the last year or two? Does that cause even more pressure that changes the supply versus demand equation in housing?
Let’s try and put this into mathematical terms, using the hypothetical $700,000 house mentioned above.
- $700,000 house
- 80% loan amount, which requires 20% down payment
- $560,000 loan amount
Under the old rock bottom rates from a month or two ago, that buyer may have gotten a 30-Year Fixed rate of 3.625% with 0 points (depending on credit score, occupancy, property type, and a whole host of other variables). Let’s say now that rate is 4.625%. That 1% rate spike causes an increase in the monthly payment of $326 a month.
- The payment at 3.625% would have been $2,553.89
- The payment at 4.625% would be $2,879.18.
A $326 a month increase is about a 12.8% increase in the monthly payment. So is the house now worth 12.8% less? No. The price of housing does not work that way. Housing prices are affected by population growth, micro economies, macro economies, supply, demand, interest rates, and many other variables. However, interest rate increases are not to be dismissed as far as having an impact on housing pricing. Some may even argue that the recent run up in housing prices was solely caused by “give away” interest rates. I believe the recent recovery in real estate prices in many areas of the country is mostly related to a shrinking inventory. Low interest rates did have some influence to help increase prices, but my guess is that prices were mostly pressured upwards by limited inventory.
So the bigger threat to housing prices may not be rising interest rates. It may be that housing prices get hurt if inventory starts to come on the market too fast and in too much supply. Let’s watch and see, but for those of you that think that interest rates are too high now and may not buy as a result, then you may really find it a bitter pill to swallow to buy with rates at 6%. A 6% interest rate range is probably considered a historic average, give or take, and I believe there will be a day when we look back and marvel at today’s interest rates, even though they are 1% higher than the rock bottom rates of a month or two ago.