Source: Image taken from http://www.forbes.com 7/15/2013.
Lots of news around mortgage rates in last few years, and particularly in 2013. According to Freddie Mac, the 30 year fixed, conforming mortgage rate hit a low of 3.31% on November 21, 2012. When I started writing this blog entry on September 19, 2013, the average 30 year fixed, conforming mortgage rate hovered around 4.5% – an approximate 119 basis point (“bp”) uptick; since then, as of November 7, the average went back down to 4.16%, 88 bp higher than the 2012 low. Nearly 1% increase seems like a big jump, as this has been a greater increase that what consumers have been used to. I regularly get questions around what this interest rate movement means for owner-occupied buyers and investors alike. Then, the second order question is how this will affect real estate valuation in the near and long term.
First, a straightforward mathematical calculation: possessing a higher interest rate on the same loan amount yields higher monthly payment. For example, on a 30 year fixed loan at last year’s historical low of 3.31%, a $700k loan amount would result in monthly mortgage payment of $3,069.51. At 4.16%, the same loan would have a monthly payment of $3,406.80 aggregating to a $4,047.06 in annual higher payment. With that being said, some percentage of this payment amount is towards interest which would usually be tax deductible for owner occupied residences so the net difference isn’t quite as large as stated above. A few hundred per month is higher payment may affect someone’s ability to carry that size mortgage, but it’s certainly a factor that need to be financially calculated and assessed against the person’s overall financial picture.
Let’s first discuss impact on mortgage rates for investment properties. Rates don’t affect cap rate (I will do a separate post on “cap rates” in the future) assumptions which investors use to help value real estate investment assets. However, it does impact net cash flow and cash-on-cash returns. Currently, investment properties face high demand from well capitalized individuals and professional investment groups. Good asset in appealing areas often produce multiple offers. This includes the 5+ unit commercial apartment building segment too. The primary drivers include i) SF Bay Area population with strong cash positions in a rapidly rising techonology stock market seeking diversified asset classes by which to invest, ii) major influx of international buyers who wish to buy and hold in Tier 1 geographies such as SF Bay, and iii) historical low interest rates to lock in for stronger cash-on-cash returns. With respect to the interest rates, this certainly is driving some of the demand as investors are looking to lock in the low interest rates for better returns.
In terms of a common question I get from buyers who wish to purchase their first home. Above and beyond the question on whether they believe the real estate values will continue increasing or if they believe prices can’t go any higher, buyers are making decisions on the following dynamic:
- Should I try to buy ASAP before interest rate rises higher?
- Or if interest rate rise higher, will that lower property values and render the higher rate better or worse than current conditions?
- Should I wait a bit to see if interest rates go back down? Similar dilemma dictates that I am more reluctant to buy now because my buying power is now lower and can afford a lower purchase price because of the higher interest rate.
- Or the 2nd order of thought from #1 above is that I believe interest rates will rise, and because of higher interest rates, I believe property values will be negatively affected. Because I have a bigger down payment to purchase a house, I would be relatively advantaged relative to other buyers who must finance a higher loan amount at the same purchase price. Thus, I may prefer to wait.
These are no easy questions and no clear answers. One dynamic that I may alert you to is the following chart compiled by Freddie Mac on the 30 year conforming fixed average interest rate since 1990 when the average rate hovered over 10%. I still recall thinking to myself when rates went below 5%, how low it was and whether it was sustainable by the Feds, but then it crepts to the low 3% last year. While it is over 4% right now, this still represents a very low rate historically.
Who knows what interest rates will do in the near future and how that will impact real estate valuations? Potential owner occupied buyers and sellers need to consider your life and financial situation. How important is home ownership to you in terms of lifestyle? How sensitive is your financial status to changes in rates and affect your ability to buy? This may affect timing and motivation. Either way, talking directly with a couple mortgage lenders is adviseable to get a sense on your situation and help determine what you can qualify for.
IMO, the answer to these questions connects to your time horizon. If you are investing, with an eye towards getting in and out quickly or having a property as part of a bigger portfolio, then these questions are burning. If you are buying it for yourself to use, with a 10-year plus outlook, it probably doesn’t matter so much. No matter how you look at it, interest rates are ridiculously low. The different between 3.8% and 4.25% is just not meaningful in terms of a life decision. There are too many other factors determining whether you pull the trigger, trying to time the market to get incremental investment value out of your own house feels foolish.