For the first time in over 20 years, buyers have to worry about rising mortgage interest rates. But many homebuyer hopefuls are happy to wait. After all, home prices are starting to fall in response. Shouldn’t I just buy in 6 months, once prices have accounted for the higher interest rate?
The answer: Maybe, but probably not.
Most people think about home prices as the listing price. But interest rates decide your monthly payment and how much house you can actually afford. Unfortunately, home prices would need to drop >30% to make up for the rise in rates from 4% to 7%.
And for most houses, that’s just not going to happen.
The supply problem
If selling requires people to buy a new home, fewer homeowners are willing to sell.
Most people do not need to sell their home. They do so for a reason – upsizing, downsizing, taking out equity, etc. Let’s consider a hypothetical homeowner, Davon, who wants to upgrade to a new $500,000 home. They purchased their home for $300,000 at 4% interest, and they know that they can sell it for $400,000. But if Davon’s new mortgage will have a 7% interest rate, it just isn’t worth it. They may be moving into a nicer home, but their payment will be >30% higher.
Home prices will drop… for the rich.
When banks raised mortgage rates, fewer home buyers could afford the increased monthly payment. Over time, this will cause the market to “shift to the left” – Buyers who could afford a $700,000 home at a 4% rate, can now afford a $550,000 home at a 7% rate.
As the inventory shrinks, higher-end prices will get reduced first, but middle-tier homes will likely stay close to flat. Why? The people who could afford a higher-end home at lower interest rates will now look at the middle-tier homes as their more affordable option. All of the buyer cohorts shift downward, stabilizing demand (and prices).
So, first-time homebuyers looking for an entry level home? Don’t expect prices to fall far.
Interest rates could keep rising
Let’s take a moment to understand why mortgage rates are rising in the first place. Banks use leverage to make money – they take deposits in and use those funds to make loans. How much they charge for that loan (AKA interest) is based on 3 factors –
- How much they pay on deposits (both today and over the term of the loan)
- How risky a loan is
- How much the collateral is worth
All three are moving in the wrong direction.
First, it’s more expensive to have money around to loan out, due to inflation and the changes in the federal funds rate. With everything getting more expensive, you are more likely to spend rather than save. Why would you do this? Simple – you are worried it will be more expensive tomorrow (and thus cheaper today). To make it worth your while to stash your money with them, banks need to increase the interest rate they pay you on your savings and checking deposits. To make things worse, the Federal Reserve has increased the interest rate at which they will loan money to banks, making it even more expensive.
Second, home prices are no longer on a guaranteed upward climb - especially on more expensive homes. Since homes serve as the collateral on most mortgages, when the collateral is worth less than the loan, the buyer may walk away from the home. This increased risk means that banks will continue to charge an increased risk premium to account for losses if a buyer defaults on the loan. A version of this is what drove the 2008 subprime crisis and created a wave of defaults and forced sales that drove down prices - thankfully underwriting standards and mortgage products have dramatically changed making a massive devaluation highly unlikely.
An Opportunity for New Ways to Buy
Timing a market is never a good strategy. Waiting to buy a house, hoping that a long term change in home prices or rates may make your payment more affordable, likely won’t play out as you imagine. Buying today, with many more options on the table, may still be the smartest move, if you can afford it.
There a number of platforms helping homebuyer hopefuls afford a new home in this frustrating market. Many help by tapping equity that existing homeowners already have. But few are creating an opportunities for first-time homebuyers, as well as existing homeowners.
Notably, HomeFounder is a platform that creates pre-order deals for new construction homebuyers. By preordering a home, you can save up to 15% on the value of a home— a great way to make sure you’re getting a home at a good value, even if prices and rates continue to fluctuate.
There are always have financing options as rates fluctuate (such as adjustable-rate mortgage loans or refinancing), but the original price that you pay for your home is a constant that you will “live with” as long as you own the home. Platforms such as HomeFounder enable you the rare opportunity to achieve meaningful savings on the purchase price. No matter what happens with rates or prices, you get to start “day 1” with an advantage that will never change.
