Author: Eric Townsend
Over the last couple of years the interest rates on home loans have been at historic lows. In recent weeks we have seen those rates rapidly rise. Those considering selling or buying a home are left wondering how rising interest rates will affect the value of homes. Here is a brief synopsis of how these changes could affect the value of housing.
Home values reflect supply and demand. Increases in supply cause prices to drop while increased demand cause prices to increase. To understand the effect of interest rates we must first understand what supply and demand is.
Supply of homes come from those willing to sell property including private home owner through a regular sale or short sale, banks with foreclosed properties, and also from owners/investors waiting on the sidelines for the right price at which to sell. Of these sellers, short sales and foreclosed properties account for the bulk of sales.
Demand for homes come from the aggregate amount everyone in a market is willing to pay for that supply. This aggregate amount is based on wages, levels of employment, availability of credit and the interest rates associated with that credit, and society’s sentiment regarding the strength or weakness of the economy in general.
So today when we look at supply and demand there are a few things we notice right away. First, supply is remaining constant. We still have several months of inventory, but that inventory remains relatively constant. With a constant inventory that is not increasing the effect of supply on the market should be nominal. Second, demand is also relatively constant. Wages and levels of employment are not going up or down either and recent surveys of consumer sentiment about the economy are improving slightly. The one thing that is not remaining constant is interest rates.
With interest rates being the one factor affecting home prices we must look at how those interest rates change the demand curve. To show the effect of rising interest rates we will use the example of the average demand (D) who is looking to buy a home. Let’s assume that the amount D is able and willing to pay is $1,340/mth. At a 5% interest rate D can buy a $250,000 home. At a 6% interest rate D can buy a $223,000 home, which means the value of the home that he can afford is $27,000 less. This is roughly a 10% drop in the value of that home. If rates rose 2% and D bought a home at 7% interest he could only afford a $200,000 home, which is roughly a 20% drop in the value of that home.
So with everything remaining approximately constant we could expect home values to level off. Unfortunately, interest rates have begun increasing. Home mortgages are based on 10 year Treasury Bonds and the rates on those bonds having increased from a low of below 2.5% just a few months ago to over 3.3 % today. With these increases mortgages rates have also begun to climb. With many new buyers subject to these higher rates principle home values should decline inversely.
On a brighter note, the effect of these higher interest rates is not reflected in values for several months. So if you are selling a home now is the time.
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