It has to sound very self serving when a real estate professional encourages homebuyers to buy now, before interest rates rise. Nevertheless, at this moment in time we are seeing a window of opportunity in Silicon Valley, and I am encouraging anyone who’ll listen that it’s time to get serious about purchasing. Interest rates have been at historic lows for a very, very long time – and that is not going to hold much longer. At the same time, we have seen a softening of home prices. The only negative for home buyers is that there’s not much inventory. This is true in many areas of the country, but especially in California, which is leading the recovery.
How important is it? The buying power is drastically improved by lower rates, and will be adversely impacted just as dramatically when the rates rise. Today I spent quite awhile calculating out what happens to payments as interest rates go up, and did so in quarter point increments. For this example, I used $400,000 since that’s a conforming loan that a lot of first time home buyers might seek, but you can extrapolate and understand what happens to a loan of $1 million or more just as easily. Please have a look:
Historically, interest rates are usually closer to 7 or 8%. But I grew up in a real estate home (my mom was a Realtor for 40 years) and I remember her selling houses when the rate was 18%. Jim and I felt lucky when we bought our first house (in the Cambrian area of San Jose) in 1989 and were able to pay 2 points to buy down our rate to “only” 10.25%. Anything lower than 8% looks good to me! My grandparents had a VA loan in the early 60s for 4.25% and I never saw numbers like that again until recently. Today’s buyers have gotten used to the “once in a generation” low rates and truly, most do not appreciate how much of an opportunity this is.
How high are interest rates expected to go in 2014?
Lawrence Yun, the Chief Economist for the National Association of Realtors, predicts that by the end of 2014, interest rates will be up as far as 5.4%. (The Mortgage Bankers Association is saying 5.3% Other economists are saying 5%. I’m not seeing anyone predicting that it will stay where it is.) And no one can foretell if it will continue to rise in 2015 and beyond. But let’s just compare the 4% we see right now with 5.5% (closest number I ran to what Mr. Yun is expecting). The difference is about a 15 – 18% increase in the mortgage payment.
Buying power diminished with higher interest rates
We could look at it the other way around, too, and ask ourselves this question: “if I had $2500 that I could put toward a mortgage payment, what would happen if interest rates rose before I locked it in?” Let’s see how much “buying power” that provides (assuming a down payment is available and so on) with the various interest rate scenarios being anticipated.
$2500 for principal & interest
4% = loan amount $$523,653
4.5% = loan amount $493,402
5% = loan amount $465,704
5.5% = loan amount $440,304
The difference between 4% and 5.5% is $83,348 for this example. For many home buyers, that would be all, or most of, their down payment! For a lot of Silicon Valley renters who’d like to be home owners, it could make the difference between purchasing a single family home (house or duet home) versus a townhouse or condominium.
What are buyers & sellers saying about the Silicon Valley real estate market?
Right now, I’m hearing a lot of buyers express exhaustion from the last year or two of an insane seller’s market, and a frustration with the lack of inventory. That “one two punch” has many thinking “let’s just wait until Spring, and maybe there will be more inventory”. I’m receiving this feedback from the majority of my home buyer clients, and my colleagues locally are hearing the same thing. Prices have softened a little since about July, so many are hoping that if they wait, inventory will be better and prices will be lower.
Sellers, who got used to a strong seller’s market, were not happy that things started softening here in the South Bay. Many who might sell now want to wait until spring, when they hope that prices will be higher.
Will prices go up? We really don’t know. No one ever does. They could go down a little, up a little or be flat for awhile. We are not hearing the economists predicting a bubble burst or a surge in pricing. We’ll have to see. But no matter what happens with the sales prices, if interest rates rise, buying a home is sure to be more costly overall. The increase in cost is there for the life of the loan. Many homeowners have not been keeping their mortgage for 30 years recently because of the lowering of the rates, but if rates begin marching upward again, we’ll see people holding onto those loans for decades, and the cost from that interest rate jump will be very substantial when compounded over 30 years.
My best advice: do not wait until spring to buy. If you can find a home that you like, that meets your needs, seriously consider purchasing sooner rather than later to take advantage of these incredible interest rates before they’re gone. If you wait, it’s possible that buying a home won’t just get more expensive. It may become impossible to get what you want and you could be priced out of the market – not because of home prices, but mortgage prices.