Will Higher Interest Rates Finally Cool The Red-Hot Housing Market?

Will Higher Interest Rates Finally Cool The Red-Hot Housing Market?

Robert Farrington

 

Will Higher Interest Rates Finally Cool The Red-Hot Housing Market?

Pretty much everyone knows the Fed raised interest rates a half a point in early May, but what does that really mean? For the most part, the Fed has been planning to inch up rates in order to deal with record inflation, which means it hopes to stem the rise in prices we’re seeing on nearly everything we buy today, from groceries to household supplies.

Rising interest rates also mean you could earn a higher return on your savings, whether you bank with a traditional institution or you park your savings in an online bank.

Unfortunately, there’s another side to rising rates — borrowing money is going to become a lot more expensive than it was in previous years.

Higher Interest Rates And Housing

Rising rates will have the most profound effects on purchases that require large loan amounts, like houses and cars. With the housing market especially, the effect of rates can easily add up to tens of thousands of dollars (or hundreds of thousands of dollars) in added interest charges over the average timeline of an average mortgage.

Consider this example:

Imagine you borrow $300,000 for a home using a 30-year mortgage with an interest rate of 4%. If you made the minimum payment of $1,432 (principal and interest) on your loan the entire time, you would wind up paying $215,608.52 in interest over 360 months.

If you jack that rate up to 4.5%, on the other hand, the monthly payment goes up to $1,520, or almost $90 more per month. Worse, the total interest charges over 30 years rise to $247,220.13. That’s more than $30,000 in extra interest charges over the life of the mortgage note.

And 4.5% is being generous. We’re seeing rates approach 6% for 30-year fixed rate mortgages. A $300,000 loan at 6% will see a monthly payment of $2,062 – over $500 more per month than a 4% loan.

Will Rising Rates Slow Down The Hot Housing Market?

Obviously, the impacts only go up from there if rates rise any higher or you borrow more than $300,000. With that in mind, it’s smart to wonder if rising rates may bring the hot housing market down a few notches, either by lowering the average price paid for homes or by slowing down the average time it takes to make a sale.

According to experts, rising rates will definitely have an impact on the housing market, although the degree of that impact and when it will be felt the most is anyone’s guess.

Some Buyers Will Be Priced Out

Real estate broker Jessica Peters of Douglas Elliman points out that, in addition to paying more in interest, rising mortgage rates can also lower the mortgage amount borrowers can qualify for.

“In terms of purchasing a property, every 1% of interest rate increase on a buyer’s loan reduces their purchasing power by approximately 12%,” she says. “In other words, if buyers do not have a hefty savings or an income that is beyond what was initially allocated, then the overall budget to purchase a home stands to decrease substantially.”

Fewer Bidding Wars

According to Daryl Fairweather, the Chief Economist at RedFin, most home buyers are still encountering bidding wars, but competition is beginning to cool as borrowers reassess their goals. Fairweather expects bidding wars to cool down dramatically as rising mortgage rates price more buyers out of the homes they want.

“That should provide some relief for people who can still afford to buy, as they’ll likely face fewer competing offers and may no longer need to offer drastically over the asking price in order to win,” she says. “Unfortunately, the slowdown in competition won’t help those who have already been priced out of home ownership and are now grappling with soaring rental costs.”

Rental Rates May Increase

Dennis Shea, who works as Executive Director of the Terwilliger Center for Housing Policy at the Bipartisan Policy Center, says he definitely expects the red-hot housing market to cool down over the coming months.

With rising mortgage rates, however, the cost of homeownership will still continue to increase even if there is a dip in home values. Unfortunately, that’s just going to create more housing pain for renters.

“As home ownership becomes out of reach for more and more families, we can expect rental demand to increase and rents to continue to rise,” he says.

More Rate Increases Could Be On The Way

According to Robert Heck, who serves as VP of Mortgage at digital mortgage marketplace Morty, where things head from here may come down to inflation and whether or not the market settles in at these rate levels.

If inflation were to spiral out of control and the Fed takes even more aggressive action, he says, rates could rise to a level at which they could send demand and affordability into a steep downward spiral.

That said, Heck notes that current market indicators are not projecting interest rate levels in the next ten years to reach a level that would send mortgage benchmarks above 7%. So now may still be a good time to buy.

“Affordability has certainly taken a hit as prices and rates have gone up, but there’s still opportunity in the market for those that are ready to buy, and current rate levels don’t automatically mean you should sit out the market entirely.”

There Is Still A Supply Shortage

In the face of rising rates, it’s important to remember that there is still a supply shortage – there are just not that many homes for sale. And given that most homeowners today have locked in their own mortgages at 4% APR or lower, it could be a tough financial position for them to list their home for sale to move.

As such, there may not be a surge of inventory coming onto the market to help lower prices.

Ready To Buy? Consider These Strategies

If you are hoping to get into the housing market before rates rise further or rental prices creep up more than they already have, there are some strategies that can help you qualify for a mortgage. Ian Katz, a Licensed Associate Real Estate Broker with Compass in NYC, says your first course of action should be tapering back the budget a bit and looking for properties offering a bit more value or an opportunity for a discount.

For example, properties 10% below a buyer’s maximum price budget would “allow for a lower purchase price and loan size to offset the increased rate environment,” he says. “If a buyer is comfortable purchasing a home that needs a bit more aesthetic TLC or has another manageable trade-off, then monthlies can be kept similar through a less expensive purchase and less debt.”

The second strategy Katz recommends involves looking at creative financing options, or considering a 7/1, 10/1, 7/6 or 10/6 AR AR -0.8%M mortgage. This move may save you anywhere from .375% to .5% vs. a 30-year fixed rate.

That said, Katz warns that a buyer going this route should proceed with caution and confidence that they can either pay down their mortgage entirely or trade up during the fixed rate period, so as not to be affected by the adjustable reset later in the loan.

“While the floating period rate will have a cap, that rate will still be comparatively quite high,” he says.

Finally, CEO Nik Shah of Home.LLC. says that one fast way to bring down your mortgage cost is coming up with a hefty down payment. Not only will you get to borrow less this way and pay lower interest costs overall, but lenders may give you a lower rate to boot.

If you put 20% or more down, you can also eliminate fees like private mortgage insurance (PMI) and monthly mortgage insurance premiums, says Shah.

Source: forbes.com

 

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