What do rising interest rates mean for you?

This week, the average 30-year mortgage interest rate reached 4.500%, a high for the last five years.

After hearing endless predictions of rising interest rates only to see them slink back down again, are higher rates here to stay? If so, what affect will higher interest rates have on home buyers, homeowners and home sellers? That is what we will investigate, so you can see exactly how you might be affected for your particular situation.

How do we know rates will stay up?

If there’s one thing for sure about interest rates, it’s that no one can accurately predict them. Interest rates are the result of the current economic climate coupled with decisions made by the federal government over the rate at which it lends money to banks.

But, we can look at historical trends – looking back instead of forward – to get a sense of where we’ve been. Here’s what interest rates for a 30 year fixed rate mortgage have been doing in the last 10 years:

When you look at rates over time, the current rate of 4.5% doesn’t look so bad, does it? But, many of us have been used to exceptionally low interest rates in the past few years, dipping to a low of under 3.5% in 2013 and again in 2016. We are used to calculating home financing based on these historically low rates, which makes 4.5% look high.

Is it different this time?

A lot of people are saying that this time is different. Sure, interest rates go up and down, but now is when they will go up and stay up. In order to make sense of this theory, I reached out to a friend of mine who is an economist, and this is what she said about it:

“So, the main difference this time is the stage of the business cycle where we are now. The expansion is “long in the tooth”, meaning eventually the economy will start to overheat, causing the Fed to respond to higher inflation by raising interest rates. Many “prognosticators” think this is where we are now. The Fed (JY) said they would raise rates three times this year. Jay Powell, the new Chairman, has made no such promise.

So, a good barometer to watch for heating up inflation is the 10-yr note yield. It is usually a precursor to higher inflation. In other words it “leads”. Inflation indicators by their very nature “lag”. If you start to see the 10-yr note yield creep up from 2.8% to 2.9% to 3.0% etc. in a consistent (this is a key word) fashion for week after week, month after month, then it means we are undergoing a “sea change” in inflation direction.

Personally, I won’t believe it until I see it. There is greater deflationary pressure than inflationary.”

There you have it, folks. The economist is skeptical.

How higher rates affect home buyers

If you are considering buying a home, or are in the process of buying a home, higher interest rates will give you less bang for your buck. Consider a $500,000 home. If you put 20% and get a mortgage on the remaining $400,000, at a 4% interest rate you’ll pay $1,909 a month for your mortgage, but at a 4.5% interest rate you’ll pay $2,026 a month (and, over a five year period, the difference in $117 per month will add up to $7,020).

Higher interest rates mean that you will qualify for a less expensive home than you would with lower interest rates. However, higher interest rates sometimes cause the housing market to cool, which can bring home prices down (though that was not the case in 2006, until of course, the crash happened!).

What can you do about it?

If you put a larger downpayment down it can offset the cost difference of rising interest rates, if that is a possibility for you. Less money to finance means lower mortgage payments.

You can also try an adjustable rate mortgage (ARM) as those have lower fees. Particularly if you know that you will be selling your home within the time period of the introductory rate, an adjustable rate mortgage makes the most sense. For example, if you only plan to be in your home for seven years or less, you could get a 7/1 ARM which has a lower introductory rate than a 30-year fixed mortgage, saving you money. However, be aware that mortgage loan officers usually need to qualify you at the fully adjusted rate, which may make an ARM off limits for some. Also, you want to make sure that you really will be selling the property within that timeframe, because if rates continue to rise, an ARM could end up being a very bad deal if you need to remain in it.

You can also decide to downsize and buy a more affordable home, given current available interest rates.

How higher rates affect homeowners

If you have a low, 30-year mortgage interest rate, then you can sit tight with the confidence that you don’t need to make any moves at all. You can drink your tea, and count your money. If you bought or refinanced in recent years, you will enjoy some of the lowest rates seen in a long time!

If you have an adjustable rate mortgage, you’ll want to keep a close eye on it, especially if you are in the adjustment period or nearing it. Your particular ARM product has a yearly cap on how much it can adjust upwards (or downwards), usually 1% or 2%. For example, if you got a 3/1 ARM in 2015, which is due to adjust this year (3 years later), it could be that your rate will increase by a large enough that you will really feel it. This is why it is good to keep an eye on your ARM and get ahead of rate increases, so you can plot out your best course of action.

To learn how your ARM will adjust, no matter what type of ARM you have, please see this video I made that takes you through exactly what you need to know about how ARMs adjust and by how much. Don’t get caught in a surprise rate increase!

If you were thinking of refinancing, you may find that higher rates now make it unattractive. But it really depends on the reason you are looking to refinance. Were you looking to save money on your monthly payments? Then, you could consider an adjustable rate mortgage, if you are looking to sell before the introductory rate expires. Were you looking to pay less interest? You could consider refinancing into a shorter term mortgage, like a 20 or 15 year mortgage. Were you thinking of a cash out refinance, to pay down credit card debt or other expenses? You might consider a home equity loan or line of credit, though be aware than home equity lines of credit (HELOC) have adjustable rates, susceptible to rising rates and costs, too.

What can you do about it?

Sit tight if you have a low interest rate, 30-year mortgage. You’re in great shape.

Get clarity on your ARM, if you have an adjustable rate mortgage. Where are you in the initial period? What’s the worst case scenario. Find out.

Consider all of your refinancing options very carefully, given your objectives.

How higher rates affect home sellers

Higher interest rates make homes less affordable because mortgages cost more. But for home sellers, it really depends where you are in the market. Is your home on the high end? You may find less of a pool of potential buyers and your buyers’ dollars aren’t stretching as far. Are you in the middle of the market? You could benefit by attracting buyers who are priced out of the higher market but now find your home a wise choice for them.

It also really depends on how hot your market is. Hot markets tend to take longer to react to interest rate changes because there is so much pent up demand, it outweighs small fluctuations. Cooler markets, where sales are few and far between, may see home values depreciating the fastest.

Of course, history defies the vision that higher interest rates bring lower home prices. Let’s take a look back at 2005 to 2008, shall we? 

Remember our overheated real estate market leading up to the recession? Home prices were rising all the way up to early 2007:

Let’s look at the same period for mortgage rates and we can see that even in a time when interest rates rose from 5.6% in mid-2005 to 6.8% in mid-2006, housing prices remained fairly flat. 

Conclusion: fluctuations in home prices are a result of supply and demand, not necessarily interest rate changes. 

What can you do about it?

To get the best price for your home, you’ll want to keep a close eye on the market. You are going to want to watch hyperlocal home prices carefully and see what homes are selling for in recent months. Here’s a guide on figuring out what your home value is, and here’s an article on how to analyze hyperlocal home values and where they might be headed.

If it looks like prices are on a downward swing, you’ll want to re-price your home accordingly. The worst outcome for you is to get get caught in a depreciating market with your home priced too high, so that it lingers on the market, compounding depreciation.

Remember, no one knows where interest rates are headed, and depending on the type of market you are in, you may or may not be affected by interest rate fluctuations. But, whenever there is a change in the market like there is now, you don’t want to be caught by surprise.

The fact is, your results for selling your home ultimately comes down to market supply and demand (are there a lot of potential buyers seeking out a property such as yours?), no matter what interest rates are doing.