Average rates on a 30-year fixed mortgage hit 5% for the first time since 2011, with the exception of two days in 2018. Assuming that expected rates stay this high, it will be the first time since 2013 that we’ve seen 5% interest rates. For context, rates this time last year were 3.38%. So, what do rising rates mean for homebuyers?
As Mortgage Rates Rise, So Do Borrowing Costs
The general rule of thumb is that for every 1% interest rate hike, buyers lose 10% of their purchase power. For a real world example, a 30-year, fixed-rate mortgage of $300,000 cost a homeowner around $1,383 at the end of December, with a 3.11% rate. Today, that monthly cost is around $1,715; not including property taxes, insurance and any homeowners dues.
The Effect on the Market
Keep in mind, even today’s higher rates — which are up by more than 20% from a year ago — are still low by historic standards. Between 2002 and 2009, rates were between 5 and 6.5%. The issue now is that inflation and high demand have created the most expensive housing market in actual recorded history. That means the big question is whether higher interest rates will create a cooling effect and what homeowners should expect going forward.
In the short term, everyone in my industry expects it to have a cooling effect, especially on the entry-level home buyers market. During the GREAT RECESSION a huge swath of smaller independent home builders went out of business and they never came back so with inventory not having a chance of catching up with demand anytime soon (based on historic under-building for the past decade plus), I think it’s unlikely we’ll see a dramatic drop in prices for single family homes. It will likely have a cooling effect on the condo market and I do expect to see prices come down there at least in the interim.
But long term, I believe the market will just absorb this and move on. Most likely buyers will rediscover and embrace the cheaper monthly loan payment options of 3, 5, 7 and 10 year adjustable rate mortgages (ARM’s). While some might be lamenting the loss of the historically low 30-year fixed rates, unless you planned this to be your forever home chances are an ARM loan was a better option than a 30 year fixed mortgage anyhow. Especially if you refinance or move within the first five years. Many buyers, myself included when I first bought in 1999 despite being in the industry, do not understand how 30-year fixed loans are structured and it’s worth the time to understand how they amortize. In short, you pay mostly interest for the first three years anyhow and only start really taking bites out of the principal loan several years in. To see how this works, search for an “amortization (aka to kill the loan) schedule” on a 30-year fixed. Here’s one from Bankrate. Scroll down past the monthly costs to see how much principal gets paid down, it might surprise you.
Questions or thoughts? I’m always happy to help!