Everyone knows mortgage interest rates are rising. The rate for a 30-year fixed rate mortgage in November of 2021 was about 3.2%. By contrast, in just six months or so, rates have gone up to a national average for a 30-year fixed rate mortgage of 5.48%. The conventional wisdom is that the Federal Reserve should keep the prime rate of interest (the rate the Fed charges banks) above the rate of inflation in an effort to keep prices from spinning into a perpetual upward spiral, and the Consumer Price Index (a major indicator of the national inflation rate) is currently increasing at an annual rate of 8.5%. So, if the Fed adheres to conventional wisdom, it should raise the prime rate of interest to above 8.5% to counter inflation. As much as any other indicator, this should forecast where mortgage interest rates are likely to go in the second half of 2022.
So
what are the implications of this for home buyers? Let’s look at a couple of examples: Most home
buyers opt to put as little money down as possible. In the case of an FHA backed mortgage or most
conventional mortgages, that means the buyer needs 3% down in cash. Then depending on income and credit, the
lender will finance the balance of the purchase. Therefore, a buyer who purchases a home for
$320,000 will typically finance $310,400 (97% of the purchase price). At a 3.2% rate in October of 2021, principal
and interest payments on a $310,400 mortgage would have been $1,342 per
month. At a 5.5% interest rate, the same
30-year fixed rate mortgage with beginning principal balance of $310,400 would
cost $1,762 per month. If rates go up to
8.5%, the same mortgage will cost $2,387 per month—more than $1,000 per month
more than financing the same $310,400 would have cost in October of 2021! This not only makes the same home less
affordable to a large number of buyers, it makes that home unattainable
altogether to many buyers.
This
raises at least two obvious questions: (1)Will increased interest rates dampen
the demand that has fueled the current extreme sellers’ market—a market that is
characterized by bidding wars and ever higher prices? (2)Is a buyer better
advised to buy now, before interest rates rise further, or wait for prices to
begin to moderate as mortgage interest rates rise into 2023?
A
discussion of the cost and benefits of owning a home vs. renting a home is
beyond the scope of this June blog post.
Suffice it to say that home ownership provides tax benefits and a hedge
against inflation that few other assets offer.
As the prices of everything rise, so generally do home prices—often at a
better rate than inflation. Home prices
rose nationally in the year between 2021 and 2022 by an average of 16%,
for example. If inflation is running at
the national average of 8.5%, housing values have been actually increasing at
twice the rate of inflation. So housing
has been and will likely continue to be a very good investment. If a buyer can purchase a home with a lower interest
rate mortgage today than he or she could in December of this year, and if home
values continue to rise, it might actually make good sense to buy sooner rather
than later—especially if rents in the Charlotte market require the buyer to pay
about the same to rent a home as to buy one.
But
what effect will rising interest rates have on home prices in general? As homes become less affordable, the pool of
potential buyers willing to enter into “bidding wars” that drive home prices
ever higher will almost certainly be reduced.
That should place downward pressure on home prices in general. However, there is currently such a low
inventory of homes available for buyers to purchase in the Charlotte metro area
that even a reduction in the overall number of buyers shopping for homes may
not be sufficient to cause a significant decrease in home values because there
are so few homes on the market. Some
experts predict that those wild increases in home values in 2021 and 2022 of
16% or 18% are likely to moderate
to 5% or 6% per year in 2023. But
that analysis still has housing prices rising, not falling. The increase in home values and prices is
expected to continue at a slower pace, but not fall—and certainly not crash, as
some have speculated.
In
the Charlotte metropolitan area, the factors that would lead to housing market
“crash” are just not present. During the
Great Recession of 2009-2010, home prices crashed because lending practices had
been so relaxed that prices had been driven up by buyers who probably should
not have been qualified to purchase. This
lead to a wave of mortgage foreclosures and a collapse of real estate
values. Today, lose lending practices are
much less a factor in driving increases in property values. The main factor today is low inventory,
and that is not likely to change in the Charlotte market in 2022 or 2023.
Every
buyer has his or her own distinct set of circumstances and motivations, and
each should make the decision to move forward based on careful analysis of
those particular circumstances. But, as
a general proposition, it can easily be argued that buying a home before
mortgage rates increase further is a sensible move to make. This is especially so if the rate of increase
of home values is expected to moderate, but home values are not expected to
drop in the next year or two.
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