The Federal Reserve has been assisting the economy by keeping lending rates as low as possible. The idea is that the with lower rates there will be increased spending, increased lending, and a general uptick in the economy. It also makes saving money in an interest-bearing savings account a mostly worthless activity.
Since the housing crisis a few years ago the government has been pushing and keeping rates as low as possible. In turn you have seen all kinds of rates go down. From home mortgages to auto loans to certificates of deposit, borrowing money is extremely inexpensive.
When interest rates on home mortgages drop you expect to see an uptick in the number of homes being bought and sold as well as the number of refinances completed. Being able to drop your interest rate 1% or more will greatly impact your monthly payment and the total amount of interest you pay over the life of the loan. That in turn leads to many people rushing out to get the next best rate.
All of that is great for the economy: realtors earn commissions, families move to new jobs or homes, builders of homes can sell new houses, loan originators get commissions, and even title companies make a little cash. When homes aren’t selling it is a huge drag on the US economy as we saw in the 2007 to 2010 time frame.
You might then expect disaster for the US economy is interest rates, including those on home mortgages, begin to rise. The assumption is that with rising rates the number of homes must go down.
Impact of Rising Rates on Home Purchases
To truly determine what kind of in impact rising mortgage interest rates will have on the real estate industry we need to consider the short term and long term.
Short Term Impact of Higher Mortgage Rates
Surprisingly, in the short term you could actually see more homes being purchased than you did when rates were at historic lows a few months ago.
This doesn’t make sense with our theory of dropping interest rates equals more homes purchased. When rates go up you should see fewer homes purchased.
However, in the short term when rates begin to rise it can have the same impact as when rates are dropping. The issue here is that potential home buyers that were sitting on the fence trying to decide whether or not to purchase a home suddenly feel more urgency to make a decision.
Each day that rates go up is a day that home ownership becomes less of a possibility. If you can find a home you can afford now, today is the cheapest the rate will be assuming you are in a rising interest rate market. The longer those potential home buyers wait the more likely it is they won’t be able to afford a home in the future.
These buyers then jump off the fence toward home ownership. This can cause a bit of an uptick in home purchases.
It is also entirely possible that these new buyers are making mistakes; just because rates are going up and home ownership is getting more expensive doesn’t mean you should be buying a home. However, in the large economic scope some unwise purchases are inevitable.
Long Term Impact of Higher Mortgage Rates
Although you can see an uptick in home purchases when rates first begin to buy, the natural course of action is that fewer homes will be purchased. How long it takes before this happens requires a lot of data crunching, but it is inevitable. If rates are at 3% today you would expect more homes to be purchased than you would if rates are at 7%.
A $200,000 home with 20% down has a mortgage of $160,000. At a 3% interest rate you end up paying$674.57 per month with a 30 year fixed rate mortgage. If the rate jumped to 7% that monthly payment amount then increases to $1,064.48.
That is almost a $400 difference. Plus the payment amounts don’t include things like homeowners insurance and taxes. The difference between the two can keep many people from buying a home. It can end up being less expensive to rent a home or apartment instead of owning when rates are that high.
How to React to Rising Interest Rates
There are two parties most impacted by rising interest rates: potential home buyers that are trying to decide whether or not to buy as well as potential sellers of properties. If you never intend to move or don’t have the equity to sell your home, then you aren’t really interested in rising rates unless you have a variable mortgage.
For Potential Buyers
If you are sitting on the fence trying to decide whether or not it is time to buy a home, take pause.
Just because rates are rising doesn’t mean you should jump at the nearest house possible.
Far from it.
Buying a home is a big life decision. You need to consider many other factors such as how much of a down payment you have, what your credit score looks like, and if you will even be living in the area within 5 to 10 years.
If you don’t have a down payment then you are unlikely to get a loan in the first place; if you can’t save money you shouldn’t be buying a home. Likewise if your credit is awful then it doesn’t matter that rates have been near historical lows; you would never receive the best rates. And if you won’t be living in the area in the short-term future then you are likely to lose your shirt in realtor costs and interest payments.
If all of the factors line up for making the decision to buy a home, it appears at this moment, that buying a home sooner rather than later makes sense. Being able to lock in an interest rate today when rates are rising is likely to be a wise decision.
But only if you really are ready to buy a home.
For Potential Sellers
When there is a new influx of buyers into a market you might be tempted to throw a for sale sign in your front yard in hopes of capitalizing. This may work for some individuals, but don’t forget that you end up needing a place to live as well. If home values start going up with interest rates, you could sell today but have to end up buying a home at a higher price and a higher interest rate in the future. Those two factors can eat up any profit you have from the sale of your home today.
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