TRICKS OF THE TRADE
What Rising Interest Rates Means to Potential Homebuyers
Prepared by: Kyle Ryan, CFP® & Michael Menninger, CFP®
Historically low interest rates may be going away. The rush to refinance a loan or to get a mortgage is beginning to slow down. The US has experienced all-time low mortgage rates for nearly two years, how did we get here?
In March of 2020, the Federal Reserve (Fed) lowered the federal funds rate all the way down to near 0% to help spur a struggling economy. The Fed lowered rates when the global economy was in dire shape as the coronavirus pandemic caused people to lose their jobs, businesses to close, and an overall shut down of the global economy. Thus, people were pleasantly surprised to obtain mortgages at rates below 3%. It is important to note here that when you hear on the news that the Fed is raising or lowering interest rates, it is the Fed funds rates, which is not the mortgage rates, but they are indirectly related.
Now, as we enter Spring of 2022, mortgage rates are back on the rise. Why is this? While the US economy is still struggling in some areas due to the pandemic, it has also created more jobs in the workforce and people are returning to work in droves. These trends are positive for the economy, which allows the Fed to raise interest rates to combat the highest rate of inflation in 40 years. So that begs the question – how high will rates go, and what does it mean for homebuyers?
Homebuyers are impacted by mortgage rates if they need to borrow money to buy their home. If an individual borrowed $200,000 at a 3% rate, their mortgage payment (excluding taxes and insurance) would be $844 per month. However, if the mortgage rate was 4.5%, then the payment would become $1,014 per month, a staggering 20% increase. If a person cannot afford the additional monthly payment, they may be forced to buy a less expensive house or offer less for the home they wish to purchase. In the end, higher mortgage rates could put pressure on the rapidly growing cost of real estate.
As we all know, real estate prices have rocketed in the past few years. This was due in part by the lower interest rates, which allows buyers to afford more for a home with the same monthly payment. The rise in real estate prices is impacted more by the historical imbalance between supply and demand. Far more people want to buy a home than are available on the market, so they are bidding substantially above the listing price.
The graph above shows the movement of 15-year, 30-year, and 5/1 ARM (adjustable-rate mortgage) mortgage rates. As you can see, while rates are roaring back up, they are just returning to pre-pandemic levels. Recency bias may make potential homebuyers believe that a 30-year mortgage at a rate of 4.45% is a bad deal, but you are still getting a rate far below the long-term average. Only a few years ago, 30-year rates were almost 5% and in the early 1980’s, mortgages rates were over 15%!
The table above shows the mortgage interest rates as of March 30, 2022. So where will mortgage rates go from here? They have rapidly increased in 2022 and the Fed expects to raise the federal funds rate multiple times this year to combat inflation, which will put upward pressure on mortgage rates. However, there is still a lot of uncertainty and other prevailing factors that make this difficult to predict. Mortgage rates are impacted by a variety of factors, such as anticipated economic growth and inflation. If we exhibit sustained economic growth, mortgage rates will likely rise. Conversely, bad economic news such as a new wave of coronavirus or the impact of the Russia-Ukraine conflict in the US could cause mortgage rates to go down again. In short, as the economy grows hotter, interest rates may rise, and rates could fall with a slowing economy.
How do mortgage rates impact the decision to buy a home? They really shouldn’t. Mortgage rates may be increasing from their historical lows, but they are still at a very reasonable rate. One should not rush into purchasing a home or delay the purchase of a home solely due to changes in interest rates. It’s impossible to time the market, but if interest rates continue to climb, then you got in early. If they drop to previously low levels, you can always refinance your mortgage later. There are many additional factors beyond mortgage rates that may impact your decision to buy a home. We strongly recommend that you consult with a qualified financial professional to provide you with guidance. If you would like to review these issues with us, feel free to contact us.
The opinions contained in this material are those of the author, and not a recommendation or solicitation to buy or sell investment products. This information is from sources believed to be reliable, but Cetera Advisor Networks LLC cannot guarantee or represent that it is accurate or complete.