Rising Interest Rates Bring Challenges and Opportunities

The Federal Reserve announced on November 1st that interest rates will remain unchanged, for now. However, analysts are all but certain that the Federal Reserve will raise rates in December, and four more times in 2018. Economic growth remained at a robust 3% in the third quarter, even with the losses from Hurricanes Harvey and Irma. Despite the growth, inflation is still languishing at 1.3%, well below the 2% target rate set by the Federal Reserve, prompting the desire for an interest rate hike.

For those of us in the real estate industry, this means we can expect mortgage rates to rise. Corelogic is predicting a mortgage rate of 4.7% by the end of 2018.

This will make buying a home less affordable, for two reasons. The first reason is that higher mortgage rates mean more expensive mortgages. A common rule of thumb in the mortgage industry is that for every 1% rate increase, consumers lose 11% of their purchasing power.

The second reason is that current homeowners will be less motivated to sell, enjoying the low interest rates they currently pay from mortgages written since the Great Recession in 2008. This will mean fewer homes on the market, further reducing affordability. CoreLogic Chief Economist Frank Nothaft predicted a 5% rise in home prices in 2018. Clearly, the mortgage industry will see some impact. The economic fallout will not be contained to one industry, though. Home buying generates billions in economic activity from appliances, furnishing, repairs, and remodels.

If you’re already a homeowner, rising home prices doesn’t sound too bad on its face. The average American homeowner saw their equity increase $13,000 over the past year. In Texas, that was $11,000 in equity increase, and in Austin, as much as $20,000 for the median priced home.

Even if you’re enjoying the increased home equity, there are still negative effects to consider. For one, if you’re unwilling to sell your home due to the increased cost of buying somewhere else, you’re less likely to move to pursue a higher paying job or better opportunity elsewhere.

Decreased affordability also reduces household formation. We saw a huge drop in the number of households formed following the Great Recession, further dragging down the economy. When young people can’t move away from their parents and form new households, downstream industries suffer.

Finally, the ability for existing homeowners to “move-up” to a bigger home, better location, or even adding a second vacation home will be greatly reduced. Again, these effects aren’t just contained to the housing industry. Real estate decisions touch most every part of the US economy.

While rising home prices and interest rates present challenges, it is no reason to lose optimism in our current market. Nationally, the unemployment rate is at its lowest level since December 2000. As the economy nears full employment, wage growth should follow. Locally, job growth and immigration continue, bolstering our housing market. Austin is still a very attractive market for skilled workers, offering good quality of life and relative affordability compared to other job-growing metros.

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