In response to stubbornly high inflation, the Federal Reserve has steadily raised interest rates and signaled that the trend is likely to continue for the foreseeable future.
The question many are asking: what impact will this have on the housing market?
First, a little background. Interest rates are still quite low compared to the last 40-50 years. Many of us remember interest rates in the range of 12 to 16%, sometimes even reaching the 18% mark. Just to put that into perspective, with a $1 million loan at 16%, your interest payment alone would be $160,000 per year, or $13,333 per month. At 5%, your interest payment would be less than $4,200.
Q: What is the impact of rising interest rates on buyers?
A: For every 1% increase in the interest rate, the purchasing power of buyers decreases by about 10%. For example, for buyers who were pre-approved for a $2 million loan on a $2.5 million home, as the interest rate increases, they would only qualify for a $1 loan. $.8 million, no longer able to qualify to buy that house.
Q: Will rising interest rates have an impact on prices?
A: Most likely. As money becomes more expensive to borrow, buyers tend to reduce the amount they are willing to pay. As you’ve no doubt heard, many homes sell well above their asking prices. I see this trend diminishing as we move forward with higher interest rates.
Q: Where do you see the greatest impact on housing demand?
A: As buyers are eligible for smaller loan amounts, they tend to be pushed down on lower priced options. For some, this means they will no longer be able to qualify for even the cheapest homes and may choose to look at condos/townhouses or search in cheaper areas further out in Silicon Valley.
Q: What impact does this have on high-end markets like Los Altos and Los Altos Hills?
A: The impacts of higher interest rates tend to be reduced in areas that are less dependent on traditional loans. Many buyers in this space use cash reserves, stock options or loans depending on their portfolios.
Q: Does that mean I should sell my house now, before interest rates go up even more?
A: It depends. If you were going to sell anyway and you were just waiting for the right time, make your decision based on the best time for you. If you weren’t thinking of selling, don’t sell now just because interest rates are up.
Q: Do rising interest rates impact valuations?
A: Not directly, but as purchasing power declines, a buyer’s ability to fill a valuation gap may also decline. We may start to see more contingent bids, waiting to see if the valuation hits “value”.
Q: What is the impact of rising interest rates on someone who already has a loan?
A: A lot of people have fixed rate mortgages these days, so they won’t be affected. Those with adjustable rate mortgages will see their monthly payments increase. Credit card interest rates will also increase, which could affect a buyer’s credit rating, reducing the amount a buyer will qualify for. This, in turn, could reduce the amount buyers can/will pay for a home. When the cost of money increases, it tends to reduce the amount someone is willing to spend.
Owen Halliday, a longtime Los Altos resident, is a real estate agent who manages Christie’s-Sereno office in downtown Los Altos. Call him at (650) 492-0062 or email [email protected].