What is going on with interest rates and the real estate market? All we know is that it is hot for both buyers and sellers!

 

WEREN’T INTEREST RATES SUPPOSED TO START RISING IN 2013?

Since the financial crisis in 2008, the Fed stepped in to help the struggling U.S. economy and lowered rates using a monetary policy known as quantitative easing. In June of 2013, Ben Burnanke announced an “easing” up of the Fed’s quantitative easing stimulus policy. They have since postponed this, which is leading to even more confusion over when rates will actually start going up – and how fast.

A recent survey suggests most economists project interest rates to rise by December if not sooner. About 35%, however, wouldn’t count on it happening yet.

If you do a google news search for interest rates and the real estate market there is absolutely no consistency with the results!

One article entitled, “Don’t Worry About Interest Rate Hikes,” will be followed by another, “Prepare Yourself for an Interest Rate Nightmare.”

Hahaha – it’s almost funny, but also a bit worrisome. I mean, just what the heck is happening, then?

Basically, there is not a clear consensus regarding what the interest rates will be doing in the next few days, months, or years. Economists that are involved in influencing rates cannot seem to agree about when to raise them, and how quickly. And speculators and journalists cannot agree about what they think the decision makers will do.

A lot of this indecision is probably due to the complexity of the situation; the pros and cons it will have on the economy are not easy to foresee. There is a risk that keeping rates artificially low can lead to sharp inflation (and ultimately another recession). On the other hand, there is a fear that raising them can squash the economy. And I sure want people to be able to continue buying houses..!

All we really know is that they are still at record lows, so looking back at history they’ve gotta go up sometime.

The chart below shows that rates have only been this low one other time in the last 200 years! And the last time was to help the nation get back on its feet after the war. (Yes, I’m old. “The war” to me still means World War II.)

Interest rates and the real estate market

NOW LET’S LOOK BACK TO 1971:

If you are reading this now there is a good chance you weren’t in the market for a house and paying attention to mortgage rates in the late 70’s and early 80’s. So let me give you a quick overview so you can appreciate where we are now – even if interest rates increase a few points!

Between 1972 and October of 1981, the 30-year fixed mortgage rate jumped from just over 7% to 18.45%!

WOW! WHAT HAPPENED IN 1980?

There were quite a few factors at play, but the primary drive in rates was due to inflation. The steep rises in the price of oil, was the major cause of inflation. I remember the rationing lines for gas; cars license plates ending in even numbers had three days a week they could buy gas, odd plates has the other. What about Sundays? I can’t remember – I was little.

Another cause is often referred to as “inflationary psychology” or the “wage-price feedback loop.” In a nutshell, prices rose so people wanted higher salaries, with caused prices to increase, which caused workers to demand even higher wages.

The Fed began raising the rates in 1977, then a major recession hit in 1980. Unemployment skyrocketed. The national average was about 11%, but in industrial areas like Michigan, numbers were close to 20%. Mortgage lenders were hit hard, and phones were pretty silent in Realtors’ offices too! Basically things were a disaster. I remember my parents not being able to afford a house, and them yelling about the 18% interest rates! And this at a time when I had no idea of what that actually meant.

What it means is, really, you can buy about the most house you’ll ever be able to with rates as they are now.

If you wanted to get a loan for $1M in 1981, with an interest rate of 18% your monthly mortgage payments would be $15,071 a month!!! (Whaaa? It’s true – do the math!)

But if you had that same mortgage (for $1M) today, with an interest rate of 4%, your monthly payments would only be $4,774 – less than a third for the same house!

Or looking at it the other way, you would only be able to buy a third of the house you could today! Maybe a detached garage?

WILL A RISE IN INTEREST RATES BE A DISASTER FOR THE REAL ESTATE MARKET? 

Well, overall: no. Interest rates are just one of the factors that affect people’s decision to buy and invest in property. Other factors include:

  • Government programs like tax credits, deductions, and subsidies
  • Supply and demand (demographics), and
  • The economy as a whole

WHAT ABOUT IN THE BAY AREA?

We don’t need to worry about the real estate market in the San Francisco – but raising interest rates will mean that you’d simply be able to buy less house.

Our economy is doing extremely well and our housing market is as strong as they come. There is more demand than supply, especially in the SF Bay Area, so an increase in interest rates will have less of an effect here than in other places with more supply. For more about this, have a look at my blog post, “East Bay Real Estate: The Luxury Market.”

SO WHAT IS THE BOTTOM LINE?

The real estate market is great right now – for buyers, investors and sellers!

 

WHY NOT JUST KEEP INTEREST RATES LOW FOREVER?

Timothy B. Lee, senior economic correspondent at Vox has a great answer:

“The reason is that pumping more money into the economy only works up to a certain point.

During a recession, there are a lot of idle resources. People are unemployed, factories are producing below their maximum capacity, trucks and ships sit empty a lot of the time, and so forth. In that situation — the kind of situation we had in 2001 and 2009 — getting people to spend more will mobilize idle resources and boost the real output of the economy.

THE TRAUMATIC INFLATION OF THE 1970S LOOMS LARGE IN THE MINDS OF SENIOR FED POLICYMAKERS

But during an economic boom, things look different. With few idle resources sitting around, there’s no way for more consumer spending to translate to more output. If the Fed cuts rates during a boom, the result is likely to just be that prices go up — inflation — without generating much economic growth.

That’s what happened in the late 1970s. The Fed kept interest rates too low for too long because it feared that higher interest rates would be economically harmful. That produced double-digit inflation that created chaos for many Americans.

The traumatic inflation of the 1970s looms large in the minds of senior Fed policymakers, most of whom are old enough to remember it firsthand. They’re determined not to repeat the mistakes of their predecessors and let inflation get out of control.

Let’s hope they know what they’re doing!”

 

RESOURCES:

http://www.frbsf.org/economic-research/publications/economic-letter/2015/october/gradual-return-to-normal-natural-rate-of-interest/

http://newswatchinternational.com/news/economists-still-expect-federal-reserve-to-hike-interest-rates-before-year-end.html

http://www.ft.com/cms/s/0/7d0e9854-73e6-11e5-a129-3fcc4f641d98.html#axzz3owGNmXMq

http://www.bloomberg.com/news/articles/2015-10-15/fed-rate-decision-qe-didn-t-quite-cut-it-so-now-what-

http://www.vox.com/2015/9/16/9340469/federal-reserve-rate-decision

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