Interest rates are rising
30-year-fixed rate mortgages hit a record low in November, 2012, hovering around 3.30% for a scant few weeks. About a month ago, interest rates started climbing when Ben Bernanke hinted the Federal Reserve may start buying fewer bonds going forward. Bond investors reacted by selling US government debt, one of the benchmarks upon which mortgage rates are set.
When investors sell bonds, interest rates increase
What Bernanke was hinting at a couple of weeks ago comes down to less demand for bonds as the government scales back its buying efforts. Investors heard “Less demand going forward” and started selling. This caused rates to rise over 15% in the past four or five weeks, from 3.3% to nearly 4%.
Rising interest rates = lower home prices
When a consumers purchase homes, they are more concerned with their new mortgage payments than they are with the principal they pay for the house over time. Lower interest rates have the effect of making higher priced homes more affordable. For example, the mortgage on a $300,000 home runs $1650 a month at 5% interest. The same monthly payment, $1650, gets buyers a $540,000 home when interest rates are 3.30%. As rates move from their all-time low of 3.30% to 4 or 5%, nominal prices will most likely decrease.
But they might not
It’s hard to say how much pent up demand there is for houses out there. If demand for homes remains steady as rates rise, home prices may stay roughly flat over the next couple of years. The question we have to answer is “how much pent up demand is there?” It’s not an easy question to answer.
Let’s try to answer it anyway
According to the National Association of Home Builders, there were about 2.1M households that were supposed to materialize but didn’t because of the Great Recession. Whether or not these 2.1M people represent any kind of “pent up demand” comes down to whether or not they can get jobs that will pay them enough to ditch their roommates, or their parents, for their own place.
Rents skyrocket when houses are hard to buy
It was difficult during the Great Recession to secure a mortgage. Even now, as we climb our way out, lending standards remain challenging. Homes don’t sell when it’s hard for consumers to borrow. When homes don’t sell, they become rental properties. Real estate companies like HomeVestors bought a ton of houses during the downturn and turned them into rental properties. Rents increase as demand increases for rental properties. Rising rents take a big chunk out of what potential buyers can afford to save for their down payments. This has a cooling effect on the housing market. Rising rates make houses harder to buy, too. Prices could drop.
Rising rates will prevent things from getting “bubbly”
Lower prices and small corrections aren’t the end of the world. In fact, they’re an essential part of a healthy real estate market. It’s easy enough to lose sight of this after what we’ve been through since 2008, when every available asset class was hit and hit hard by one of the biggest market corrections in the history of the civilized world. As long as rates don’t rise too fast, the resulting price corrections will keep the real estate market from blowing more dangerous bubbles.
About the Author
Kamiel Moore is a real estate expert from Dallas, TX. In her spare time, she likes to cruise down to the gulf and hang out on the beach.