I know a lot of you have heard the news that the Federal Reserve has decided to raise rates for the first time in nine years and you’re probably scared, but I want to set your minds at ease about this and let you know what to expect from it. It’s not all doom and gloom, but this announcement is significant and could have a long-standing impact on the real estate market, as well as the wider economy if homeowners and buyers can’t see the road ahead.
So, I guess let’s start with some history of interest rates and real estate sales and stuff and move on to some common questions you, an entire generation of homeowners / existing borrowers who have never experienced an interest rate hike, may have. How’s that sound?
Update: The Fed lifted its key rate by a quarter-point to a range of 0.25 percent to 0.5 percent on 16-Dec-2015. Rates on mortgages aren’t expected to rise much soon. Long-term mortgages tend to track 10-year U.S. Treasury yields, which will likely stay low as long as inflation does.
Living in a World of Changing Interest Rates
When I was a young agent in 1998, I was given a valuable piece of advice, “Pay attention to Alan Greenspan. That man can change the heat of the market with a word.” For those of you who aren’t old enough to remember Alan Greenspan, he was the Chairman of the Federal Reserve from 1987 through 2006 — and he was the guy who announced all the decisions about whether rates would rise or fall.
Interest rates rose and fell a lot back then, enough that advice about strategically locking rates was something Realtors were expected to give to their clients. Sometimes, it was better to wait as long as possible to lock because rates were expected to fall, sometimes they looked like they’d rise — it was a gamble, but we all took it as a matter of course. Looking back, I think we stressed over those quarter of a percent changes too much, but our clients believed they were important, so we became fanatical.
Anyway, between 1998 (when I started caring about real estate) until 2005 or early 2006, the talk was always about interest rates. What’s Greenspan doing this week? How will this affect clients? Then the bubble started bursting and we only cared about salvaging our clients’ financial futures as they watched their equity drop by thousands of dollars each day.
But don’t let anybody lie to you — that bubble wasn’t caused by our seven or eight percent interest rates. It was caused by a lot of building instability in the economy, some dirty trading on Wall Street and a lot of irresponsible lending that made that dirty trading possible. Michael Lewis’s “The Big Short” is a compellingly complete account of those maddening days if you’re interested in a long read on the topic.
Interest Rates in Recent History
Interest rates have risen and fallen throughout the history of American finance and the real estate market has continued to function. Currently, the Federal Funds Rate sits at 0.125 percent, the same place it has been since December 16, 2008. Although this rate doesn’t directly dictate mortgage interest rates, it does indicate how much it costs banks to borrow money to fund instruments like mortgages, so it’s an indirect influence. That’s why we watch it so closely — when the Federal Funds Rate goes up, so do mortgage rates, student loan rates, credit card rates and so forth.
Because the Federal Funds Rate has been sitting around 0.125 percent (actually the target is a range of 0.0 to 0.25 percent), mortgage rates are literally as low as they can conceivably go. The Feds started dropping rates in September 2007 in response to housing prices that began falling precipitously in the the third quarter of 2005. With quarter after quarter of economic contraction, housing market destruction and fire and brimstone, they thought it would be enough — but it wasn’t. It wasn’t enough to simply have rock bottom interest rates to get people back into the real estate market.
But let’s go back further. Let’s see what happened when rates were rising, say June 1999 to January 2001, as the Federal Funds Rate rose from five percent to 6.5 percent, pushing mortgage rates up to seven to 10 percent. The Federal Housing Finance Agency shows that housing price indexes nationwide continued to rise, despite those rising rates — from 1.49 to 1.55. A slight rise, to be sure, but any positive results in the face of increasing rates means buyers are still buying and housing continues to be a valued commodity.
If you look at those two linked charts closely, you’ll see that another period of interest increases happened right before the real estate bubble burst — I don’t believe that data is good for forecasting the future of the market today because of a lot of other factors that were influencing home sales at the time. That market became a wildfire that no one could stop before prices ultimately exploded to highs that home buyer salaries couldn’t match. Today’s market is much more like the one we had in 1999 to 2001, slow and steady.
Today’s housing market sits at a house price index of 1.27, as of third quarter 2015. First quarter 1991 was the year that the Federal House Finance Agency’s index uses as the zero point and the highest index value (2.62) was reached during third quarter 2005. The value of homes has fallen to an index level similar to first quarter 1998 (1.23), but I believe this is just part of the value normalizing process and not anything to get upset about.
Now Taking Questions
I imagine that if I were you, I’d be pretty freaked out about the interest rate increase coming this week. Here are some of the questions I’m betting you’re asking yourself and others:
Should I buy now? Will I miss my chance if I don’t?
No. No, you shouldn’t rush out to buy a house if you’re not ready and the time isn’t right. Yes, the rate is going up, but the expected rate increases will be slow and incremental.
At today’s rate of 4.125 percent (according to Wells Fargo), your payment and interest on a 30 year fixed rate mortgage for $150,000 will be $855.72. The forecasted rate increase is just 0.25 percent, moving your rate to around 4.375 percent for the next quarter and your payment to $877.68. It’s only slightly more than $20 extra, a much smaller cost than what you may pay for rushing into the wrong mortgage or buying any house you can get.
Do not rush into buying half-heartedly, but if you’ve been preparing for a new home purchase and have just been waiting for the right time, this is it. The market may heat up, though, on this news so prepare for a lot of competition in this winter market.
How high will interest rates go?
I don’t know. That’s the truth of it. However, considering how sensitive that the Federal Reserve Board has been to employment and economic indicators, I can’t imagine we’ll ever see rates above eight percent again. Historically speaking, since 1983 rate-hike cycles have averaged 13.6 months, so even if the Feds raised rates every single month by 0.25 percent, at the end of 13.6 months, the Federal Funds Rate would only be 3.525 percent. That might mean interest rates around six to eight percent — still very doable for most home buyers.
However, at this time, the Fed doesn’t foresee rates rising that high — according to the Financial Times, “The Fed believes the rate compatible with stable growth and prices has sunk sharply because of the lingering effects of the [real estate] crisis and will increase only gradually. In this subdued post-crisis world, the central bank will need to keep its foot on the accelerator for some time to come.” So, in short, they think it’ll be a long, slow climb back to normal.
What will this mean for the value of my home?
Ah, now that’s a trickier question. The weird thing about interest rate hikes is that they tend to not have much effect at all in the long term. Looking at historical data, the rate hike cycle that lasted from June 1999 through May 2000 saw average prices go from $165,600 to $170,500. In the prior rate hike cycle, lasting from February 1994 to February 1995, prices went from $153,000 to $151,000. In my opinion, both of those are fairly flat changes — just a 2.9 percent change at very best.
That’s the long view by the data. However, something I noticed upon an announcement of rate increases when I was an agent was that buyers often panicked and rushed into purchasing anything — and they’d fight over the chance to buy even the worst house. Temporarily, in markets with very limited stock, your home might become a gold mine. Once people accept the new market reality, though, prices will return to normal.
Will this news make my home harder to sell?
No, it shouldn’t. Since the rise in rates is so small, the pool of buyers for your home will remain more or less the same. A few may drop out, but they’ll be replaced by buyers in the price range above yours that are now forced to shop for a less expensive home. If anything, rising rates will make your home easier to sell in the short term since many buyers will be in a rush to buy now in hopes of avoiding higher interest rates.
The Bottom Line: This Rate Hike Isn’t the End of the World
I know you don’t want to pay anymore than you absolutely have to in interest, but I promise you that this rate hike isn’t going to amount to a hill of beans in the grand scheme of things. What will make a huge difference to your personal financial future is rushing into a purchase, not carefully considering your options and choosing any loan program that will approve you, as opposed to the one that is best for your situation.
At the end of the coming interest rate panic, people will continue to buy and sell, and you will, too. This is the way the real estate market should be functioning, rates were never meant to be scraping the bottom of the chart for this long. Rising rates are a signal that the economy is finally turning around — it’s a great thing.
If you’re interested in buying a home while still saving on interest, do it this year. Unless the market does something unexpected and crashes because of a mere quarter of a percent rise in interest, the days of higher than minimal interest are returning and will be here to stay for the foreseeable future. Those of you not ready to buy this year may want to think about looking for a home with an assumable mortgage when you are — you’ll still get those pre-hike mortgage rates without having to rush into making the biggest purchase of your life.
Whatever you do, don’t feed the opportunists that are likely to spring up in the wake of rising rates. If you can’t qualify for a decent mortgage, don’t get one. Don’t fall for whatever new and exotic mortgage options appear, don’t count on rising prices to overcome negatively amortizing loans and absolutely don’t sign any paperwork you don’t understand and can’t be adequately explained. If we all act cool, we’ll get through this yet.