It seems like with each passing month the real estate market gets more complex and harder to predict. In the last few months we’ve seen the effects of rising wages, inspired millennials, gas hikes, housing and supply shortages, inflation, international tensions, and even Disney World is in the headlines.
In addition to all that, the Federal Reserve is trying to keep markets stable by slowly and methodically raising interest rates. While a great idea in practice, it’s homebuyers that will see and feel the most immediate effects. What does this mean for buyers? How much does a one point increase in interest rate impact monthly payments?
Take a look at the chart. We’ve broken down the monthly impact of interest rate increases for the entry, middle and upper segments of the market.
For an entry level condo buyer, you can see that the interest rate rising from 3% to 4% on a $250,000 loan means about $140 more per month. It’s real money, of course, but in the grand scheme of things it’s not a huge amount. Perhaps that means tapering off a Starbucks habit. An interest rate hike to 5%, now $290 more than our 3% baseline, and we’re close to a typical car payment. At 6%, we’re nearly $450 over our baseline and looking at a monthly nut that might give a homebuyer pause or even discourage them from buying.
On the high end of the chart, you can see how the payment gets exponentially higher as rates climb from 3% to 6%. It’s a $1,780 monthly difference on a $1,000,000 loan. That’s $21,360 per year. On a $300,000 salary needed for this size loan, that’s a 7% reduction in disposable income.
These examples show how the rising rates put pressure on both ends of the market. For the first time buyer it’s a bigger stretch to get into home ownership. They have the option to continue renting and will do so if it makes more economic sense. At the high end, a homeowner is less inclined to trade up. For them, buying a more expensive home means giving up their current rate of 3% and having to now borrow at 5%.
What does this mean for today’s buyers? Rates are currently around 5%. So those looking to buy today will pay more in interest than if they had bought five months ago. The good news though, 5% is still a great rate. We are still well below the historical average of 7% interest rates. There was even a time when rates hit 16%. (On the plus side, Disco was effectively dead by 1981, so some good came from that era).
Perhaps though, the increase in rates will do what it’s supposed to do, cool off the market. Market shifts take months to play out and it’s still too early to tell. We have noticed the aggressiveness of multiple offers has started to calm down. At the moment though, the ongoing inventory shortage is still giving sellers the upper hand.
So here is my take: interest rates are likely to go higher, regardless of rates, people still buy houses, and buyers rarely regret purchasing their perfect home.
