Food For Thought on Interest Rates.

Too Much Emphasis?

Nobody can argue that the recent upheaval in home mortgage interest rates has had a profoundly detrimental effect on the local real estate market. As I noted in the mid-year review, the number of transactions and the corresponding sales revenue hit all-time lows when rates peaked near 8%, and those figures have yet to recover even as rates start to creep back below 7%.

That spike in rates not only took a significant number of buyers out of the market, but it also kept quite a few sellers from putting their homes on the market. Who would want to trade their pandemic-friendly 3% mortgage for a rate that's easily twice that rate? That reluctance to sell is very evident in the statistics over the past 18 months — a record low number of homes were listed in San Carlos during that period. It's hard to argue with solid data.

But is this reaction by both buyers and sellers justified, or is it an overreaction?

While it's just about impossible to predict the future of mortgage interest rates, here's how I believe things are going to shake out moving forward:

• The Days of 3% Loans Are Over. Short of us enduring another pandemic or the economy falling into a catastrophic recession — neither of which we should wish for — you're not going to see 3% (or less) home mortgage rates again in our lifetime. There are just too many forces, most notably inflation, that are pushing in the opposite direction. So if you're waiting for rates to drop back to 3%, you're going be miss this market and many others.
• 5% Will Be the New Norm: At the outset of the aggressive rate hike policy, the Federal Reserve stated that their goal was to get inflation back down to 2%, which would have translated into home mortgage rates as low as about 4%. But despite all of the aggressive rate hikes over the past 18 months, inflation is remaining stubbornly high, and we're nowhere near their target rate of 2%. There are some economic experts who question if 2% inflation is even a realistic target, especially when you consider our strong job market and low unemployment. So 5% is a more realistic landing point for home mortgage rates.
• It's Going To Take Several Years. If we've learned anything from watching the Fed battle inflation, it's that getting to that 5% level is not going to happen overnight. More likely, it's going to be a couple more years. There were supposed to be 4-5 cuts in the Fed rate in 2024; now, we'll be lucky if we see two. So expect this attrition of interest rates to be a slow glide downward, and not a sharp step.
• When Rates Drop, Prices Will Rise: As soon as rates drop back what today's buyers consider to be “affordable”, more of them are going to jump back in the market which will create even more demand for housing that's not there — which means higher prices. Even if lower rates entice more sellers to move, those numbers will pale to the number of buyers looking for homes, thus keeping it a strong sellers market.

So armed with that information, is there a benefit to waiting until rates drop to 5% before you buy or sell a house?

The Bigger Picture.

When we take a step back and see where we are at now (7% rates), versus where are ultimately going (5% rates), it's not as huge of a jump as many might think. I found this infographic on Yahoo Finance a few weeks ago:

The graph above shows the monthly payment for three different loan amounts when the rate goes from 7% to 6% to 5%. The $1,000,000 loan is the most applicable to this market, so we'll focus on that one for the sake of this discussion.

The difference in monthly payment for a $1M loan at 7% (current rate) versus 5% (target rate) is $1,285 per month. While this is not a trivial chunk of change, it's certainly a much smaller gap than I thought it would be. And in all honesty, for dual-income couples with tech or biotech incomes (which is the majority of home buyers in the area right now), I'll take a leap here and state that an extra $1,285 per month is pretty doable for most of them.

So is it a good strategy for a buyer to wait until rates get back down to 5% before getting back in the game? Let's look at the numbers: If rates were to hold at 7% for two years and then drop to 5% immediately, then the difference in mortgage payments between the two rates is about $31,000 over that span. But the reality is that rates won't act that way — they will decline gradually. So for the purpose of this discussion, let's assume the difference in two years is really $25,000.

By waiting to buy until rates drop to 5%, you're essentially betting that the average price of a San Carlos home will not appreciate by more than 1.25% over those two years ($25K is a 1.25% increase above $2M, the average price for a home in San Carlos.

But with rates dropping and buyers expected to be entering the market again in great numbers, you can almost certainly bet that home prices in San Carlos will appreciate by more than 1.25%. You need look no further than this year — the median price of a home in San Carlos already jumped by over 5% from 2023 to 2024 and that's without any significant reduction in interest rates.

In the simplest of terms, the money you think you'll be saving by waiting until rates drop will most likely be wiped out by a greater increase in housing prices over the same period of time.

It's time to get back in the market.