Over the last few years we have been enjoying "artificially" low interest rates thanks to the Federal Reserve (Fed). Their involvement has kept rates at record lows in hopes of stimulating and nurturing the housing recovery. In June they announced that they would begin slowly pulling out of the bond buying market starting in 2014, which will cause rates to rise even further. Predictions are in the 6-7% range by next year. While this is a dramatic increase from the 3% we have become accustomed to, it's important to remember that it would still be historically lower compared to the last 40 year average. As I said, these current rates have been "artificially" low and were not meant to last. In a large part they have done their job as the housing market has begun to recover, although, we still have a long way to go.
NOTE: I encourage seller's to read this too since buyer mentality affects your ability to sell and afterwards you may become a buyer yourself.
Is this a good time to buy?
The original housing bubble was caused by loosening lending guidelines that allowed almost anyone to qualify for a home regardless of income or credit. This caused a feeding frenzy that shot home prices out of control. When the bubble burst, all lending stopped! Almost over night the entire housing landscape changed as buyers were denied loans and sellers were stuck in their homes. With buyers having no ability to buy homes anymore unless they had cash, home prices plunged. The Fed realized that the only way to get buyer's buying again would be to help get the lenders back on their feet (a controversial subject that I have no intention of touching here) and get rates low enough so that buyers could actually qualify for a mortgage in the new economy.
By making the rates so ridiculously low, it re-injected much needed interest as well as increasing buying power to qualified borrowers. The theory behind the Fed control of interest rates is that as the economy improves, jobs open up, and people start making more money; they can afford more home. This means (in theory) that they can raise rates slowly without hurting the housing recovery. All of this assumes of course that the job reports continue to show signs of improvement.
As a potential buyer in this market you should be asking yourself two questions;
1) Will rate go back down?
2) Will home prices continue to rise?
The answer to the first question is probably not. The era of artificially low rates is over. It is costing our government a tremendous amount of money to keep these rates low and our budget simply can't sustain it forever. Like it or not (pending some sort of disaster) the Fed is pulling out and the market will decide what the rates should be.
The answer to the second question is maybe. As of this writing, it is a "Sellers’ Market". What this means is there are more buyers then there are inventory of good homes for them to buy. This drives home prices up as demand for housing increases. Should that slow down due to higher rates happen, then those increases could stagnate. Unfortunately it's too early to tell what will happen to home values. But (AND IT'S A BIG BUT), it may not even matter (see the example below).
Using a home price of $185,000; let us see how these scenarios affect you.
Price Rate P&I
A) $185,000 4.3% $ 915.51 (Average Rates Today 10/2013)
B) $185,000 6.5% $1,137.72 (Possible rates next year)
C) $170,000 6.5% $1,074.52 *** (Possible rates next year with price drop)
***What is interesting here is that if you wait till next year in hopes that home prices drop, after less than 5 years the home would actually cost you more to own than if you bought it now at a higher price!
Here is why:
Yearly interest on a mortgage of 4.3% breaks down like this:
Yr1: $7,894.54 / Yr2: $7,758.95 / Yr3: $7,617.41 / Yr4: $7,469.67 / Yr5: $7,315.44
Total interest paid for the first 5 Years: $38,056.01
Yearly Interest on a mortgage of 6.5% breaks down like this:
Yr1: $11,964.12 / Yr2: $11,825.63 / Yr3: $11,677.88 / Yr4: $11,520.22 / Yr5: $11,352.01
Total interest paid for the first 5 Years: $58,339.86
*** So after only 5 years of ownership you will have paid $5,283.85 more for the property that you paid $15,000 less for! What's worse is that number continues to grow every month eventually costing you a whopping $91,372.92 over the 30yr term of your mortgage!
So if you are waiting for rates to go down, don't because they are only going up from here and if you are waiting for home prices to fall, don't because of what I just explained above. The time to buy is now!
Is this a good time to sell?
There are many reasons people need to sell that have nothing to do with the market such as Divorce, Probate, Foreclosure, etc. For those sellers the decision is not always up to them and they make due with the market they are in. But what if you're not in distress and simply want to sell to upsize, downsize, or relocate? You want to maximize your home's value so you can net the highest amount of money. For you the only question is will home prices rise or fall in the near future.
No one can predict with complete certainty what will happen to home values, however, by understanding what affects home prices, we can make an educated guess. To put it simply, a home is worth what a buyer is will to pay for it. An easy enough concept to understand as long as that buyer is paying all cash for the property. However, once you add financing to the equation, it becomes a bit more complicated.
Over the last 7 years one of the biggest issues we have had in the real estate market were low appraisals. Let's say a buyer wants to buy a home on sale for $200K. He or she has been prequalified for an FHA loan for $200K and has just enough for the 3% down payment and closing costs. The buyer and seller sign the purchase agreement and inspections and financing begin. In about two weeks the lender completes their appraisal of the home and find that it only appraised for $190K. Since the lender will only lend on the lesser of the purchase price or the appraised value, the buyer would need to come up what an addition $10K that he or she may not have. So even though the buyer was willing to pay $200K for the property, the lender was not and the deal has to be re-negotiated or cancelled.
Thanks to plenty of cash buyers and investors both foreign and domestic, we have seen a steady uptick of appraisable property values again. This coupled with the artificially low rates have created a "Seller's Market" of low inventory and higher prices. What this means for you is that smartly priced homes today will sell faster and for more money.
What might cause home values to go down again?
The new issue we will face with the rise of interest rates will be the decrease in a borrower’s “buying power”. Communities typically are divided by invisible lines that determine their value based on location, construction, and design. Each area attracts buyers of a particular economic range that can afford homes in those areas. Because the rates have been so low, buyers have been able to pay more for homes (as long as they appraise) without increasing their mortgage payments to the point where they can no longer qualify for their loan. When rates rise, that buying power goes down because at the end of the day, the buyer is still making the same amount of money. The buyer has no choice but to offer less for a home in order to not exceed his/her debt-to-income ratio or pull out of the market. If sellers don’t budge on price because they are unaware of this and buyer’s withdraw from the market or look elsewhere for homes, the inventory of unsold homes may rise. When that happens, we may switch back to a buyer’s market due to the oversupply and eventually you may see a dip in home values again. I don’t believe this would be a severe or permanent dip but rather a “market correction” resulting from the artificially low rates that will balance out over time.
So do you sell now or wait?
There is no question that if you want or need to sell, now is the perfect time to do so. If you’re concerned that after you sell you don't want to have to buy in a "Seller's Market" yourself; keep in mind that in the long run, you will benefit more from the lower interest rates now rather than the higher ones later (see buyer’s section up top).
In conclusion, it's important for us to educate ourselves in the current real estate environment because I truly believe that we are on the tail end of one of the greatest times to buy or sell that we have seen since the initial bubble burst over seven years ago! No one can predict the future, but regardless of what happens, I'm confident that the real estate market and our economy as a whole will continue to improve. We will have our ups and downs but what's important is that we learn from our mistakes and emerge from them better than we were before. The time to take action is now!