Uncategorized August 6, 2014

What Do Rising Interest Rates Mean?

Question: What do rising interest rates mean for buyers/sellers now?  

Answer:  Interest rates increases will have a huge impact on both buyers and sellers.  With rates at historical lows, currently near 4%, the only way to go is up and the consequences will be significant.

For the last several years the Federal Reserve (our Nations Bank) has pushed down interest rates trying jump start the economy coming out of the Great Recession.  And they have been successful.  With the economy and the housing market clearly on the mend, rates will now rise.  How much we do not know, but even one percentage point can make a substantial impact.

For example, a young couple, first time homebuyers, gets Pre-Approved by their lender for a loan of $240,000.  At a 4% interest rate, that means debt service of $9,600 per year, or $800 a month.  (There actual house payment would be closer to $1,500 per month as the payment would include principal on the loan, property taxes, homeowner insurance and possible Mortgage Insurance…more on this later). 

If rates rise just one percent, to 5%, the debt service is $12,000 annually or $1,000 per month.  A two hundred dollar increase; money that must go to the bank, not other things like, groceries, car payments and maintenance, entertainment, etc…  For most young families that is not a trivial number.

For sellers this has major implications also.  Most buyers get Pre-Approved for a loan based on the monthly payment, (a percentage of their income combine with taking into account their other debt).  So, the buyers get approved for a $1,500 a month house payment.  At 4% interest, they can buy a $240,000 home.  At 5%, they can only buy a $220,000 home.  So for sellers, rising interest rates will keep a lid on price appreciation as there will be fewer qualified buyers for their home.

But don’t let this scare you, my first home loan had an 11% rate.  Things were quite different in the early 1980’s, I actually had some hair!