US Mortgage Rates Soar Slowing Down Home Sales

Rusty-Tweed

Rusty-Tweed

The list of things that affect homebuyers’ mood is quite extensive. In fact, anything from the state of the economy and home prices to politics can affect someone’s willingness to buy. One of the most obvious factors that determine how likely people are to take out a mortgage, however, is the interest rate. After all, the amount of money necessary to cover the cost of lending will usually be directly related to someone’s likelihood of taking a large loan. With that being said, how are the current interest rates in the United States affecting the housing market? Not well.

Growing Costs

Over the last seven years, interest rates on mortgages have constantly been increasing. In fact, some of the highest rates since 2011 were seen in May of this year. This means that the cost of taking out a mortgage is continuously growing. Given that the median home value is also slowly going upward and the recent tax law changes, homebuyers may lack the motivation to purchase.

The Direct Relationship

When it comes to financial decisions, there are always factors that are directly related to the choice one makes. For example, prices of gas are directly related to someone’s potential car purchase as gas will be a repetitive variable cost. When it comes to the housing market, mortgage interest rates have the same role. Just consider, for example, what will be the most important factors in determining if someone signs a 30-year long loan agreement. Undoubtedly, the interest rate is extremely important.

Given the compounding nature of mortgage interest rates, a minor difference of 0.5 percent could mean tens of thousands of dollars. For instance, if someone takes out a $100,000, 30-year mortgage at an interest rate of 3.5 percent, they will repay a total of $161,656. If that same loan comes at the interest rate of 4 percent, the total amount will accumulate to $171,870. Thus, more than an additional $10,000 will have to be invested into the loan due to a minor change in the interest rate. If the mortgage is greater, this is even more impactful, as the differences could be measured in hundreds of thousands of dollars.

Facilitating a Slower Market

With interest rates growing, buyers are not as likely to purchase. Given their lack of motivation, home builders will not exactly be eager to construct new homes. After all, it makes no sense for businesses to build homes that will not be sold soon. Thus, the supply becomes limited and causes the prices to go up. After all, when the number of homes in the market is limited, the buyers will have to outbid one another. In the long-run, such practice will cause the prices to increase.

Sadly, this could throw the entire market into a vicious cycle. The prices continue to go up, and buyers are forced to seek greater mortgages. Given the growing interest rates, however, those mortgages come at a very high cost. Thus, the buyers’ motivation diminishes further. Luckily, with the improvements in the economy and the low unemployment, the interest rate should slowly decline. If they do, buying homes will become a common practice.

Millennials and the Housing Market In 2018

Rusty-Tweed

Rusty-Tweed

Although millennials are associated with some negative terms, their buying power is hard to deny. A part of it has to do with buyers’ confidence levels running at a 15-year high and the economy performing well. Unfortunately, as many as 32 percents of all millennials in the United States currently live with their parents. Since these are individuals aged 20 to 36, their total number is around 75 million. So, there are presently almost 25 million young adults who still live at their parents’ homes.

Generally speaking, that number may not seem as impactful given the total population of the United States. It is, however, very impactful indeed. Having 25 million people out of the housing market indicates that there is a ton of untapped spending potential. Meaning, the overall economy is suffering because the housing market is not utilized to its full potential. So, what are some of the main reasons for this situation and how could it be fixed in 2018?

Employment Rates

Even without using empirical evidence, saying that the employment history has a lot to do with homeownership makes sense. Luckily, the United States is currently experiencing some of the lowest unemployment rates in the history. This indicates that the spending potential of young adults is amplified by the fact that most of them have jobs. Meaning, their power to purchase a home will steadily increase until they finally begin taking advantage of their financial abilities.

Interest Rates

Another factor that is undoubtedly motivating people, not just millennials, to buy homes are the low mortgage interest rates. Ignoring their short-run growth, current rates are low when compared to historical numbers. Adding the fact that a lot of experts believe how the average home prices will go up by 5 percent in 2019, the urgency to buy increases. Hence why it is reasonable to expect that millennials buying homes is just a matter of time.

Tax Laws

Although the previous two reasons are supporting millennials’ buying power, there are some issues at hand. The first one pertains to the tax laws that were recently changed. In 2017, President Trump facilitated a major tax overhaul in the last three decades. Doing so reduced the mortgage interest deduction, got rid of the moving expenses itemized deduction, and changed the tax property deduction. Although most of these are easy to understand, it will take some time for investors to get on-board. Meaning, those millennials that are in the real estate sector will need a few months to figure out ways around new provisions to maximize returns.

Low Supply and Rising Prices

Over the past two years, the supply of housing opportunities has considerably deteriorated. Given the high number of people that are not buying, many projects stopped, and homes are not getting constructed as fast. As a consequence, there are fewer homes than people want. When that happens, the equilibrium is shifted, and prices go up. The problem, however, is the fact that these prices are consistently rising. Although real estate investors love the trend, average buyers are not fond of it.

After all, when home prices are rising faster than workers’ salaries, they are unable to buy. Consider, for example, a market where the median property value went from $550,000 to $700,000 in 3 years. If somebody who lives there did not receive the same 27-percent increase in pay during those three years, they would not buy a home. Thus, low supply that causes prices to rise is another reason why millennials may be less likely to buy. Eventually, however, these trends should normalize to put the market back into equilibrium.

Knock-on Impact of Low Interest Rates

8.4.16 | Knock-on Impact of Low Interest Rates – Rusty Tweed team

Record Low Yields

The yield on 10-year U.S. Treasuries is at a record low of 1.36% (7/8/2016). Its previous record low was in July 2012 when investors were nervous that Spain needed a full-blown bailout. The recent slide in rates has led to lower prices for bonds and a record high rate of investors buying U.S. Treasuries.

Analysts at LPL Financial think investors will continue to flock to bonds because they “remain more attractively valued compared to their overseas counterparts in Germany and Japan”.

Impact of Low Interest Rates on U.S. Stocks

 U.S. stocks are close to their all-time highs. They suffered a hit immediately following Brexit, but have recovered quickly. Companies like Johnson & Johnson (JNJ) – up 20% this year; and Kimberley Clark (KMB) – up 10% his year – have high dividends. This suggests that investors who might normally purchase bonds are instead buying riskier stock in order to get a greater yield and return.

However, whenever U.S. interest rates rise, stocks could take a hit. In addition, a strong dollar impacts U.S. trade as goods made in the U.S. look more expensive on world markets.

Knock-on Impact of Low Interest Rates - Rusty Tweed team

Impact of Low Interest Rates on the Real Estate Market

Low interest rates stimulate the real estate sector by making it cheaper for individuals and businesses to borrow money to invest in real estate.

 Mortgage rates are tied to Federal Reserve interest rates. When rates are low, as they currently are, a homeowner will pay significantly less across the duration of his/her mortgage for the same priced home. Cheaper mortgages create an incentive for people to buy homes.

Since U.S. interest rates on bonds and CDs are so low, investors and retirement funds are buying increasing amounts of real estate in order to get the rental income, which is significantly higher than bonds or CDs. In turn, this is pushing up rental properties valuations.

References for Knock-on Impact of Low Interest Rates – Rusty Tweed team:

http://money.cnn.com/2016/06/28/investing/treasury-bonds-brexit-flight-to-quality/?iid=EL

http://money.cnn.com/2016/07/05/investing/us-10-year-bond-yield-record-low/

http://www.investopedia.com/ask/answers/052815/how-have-low-interest-rates-affected-real-estate-sector.asp