Low mortgage rates the past five years or so have made homes more affordable, despite the median national home price rising 45 percent since 2011.
Low interest rates have offset higher home prices, making 61.4 percent of homes affordable to median income earners in the third quarter of 2016, according to the National Association of Home Builders’ Housing Opportunity Index, or HOI. A 50 percent or higher mark is considered affordable, which is what the index has been at or above for nearly the past nine years.
It defines an “affordable” home as one where a household spends 28 percent or less of its monthly income on total housing payments.
Rates on 30-year fixed mortgages, however, are slowly rising again. A 30-year fixed-rate mortgage averaged 4.08 percent for the week ending Dec. 1, according to Freddie Mac. A year ago it averaged 3.93 percent.
The presidential election had an immediate impact on interest rates and stocks. And the Federal Reserve has signaled that it will raise interest rates in December and into 2017, with the increases eventually making their way to home loans.
Supply and demand
While homes have been affordable the past nine years, home prices have increased since hitting lows in 2011. The national median home price in the third quarter of 2016 was $247,000, compared to $170,000 in 2011, according to the HOI. The last time home prices were this high was in 2006.
It sounds odd to hear, but higher interest rates could drop home prices and make it easier for home buyers to afford a home, some analysts say.
“Higher home loan rates are only good for buyers if it causes sellers to reduce the price of the home,” says Jonathan J. Monjazi, founder of Monjazi Capital and an investment advisor.
“In order to accommodate the higher rates, sellers have to reduce the price of the home so that the monthly payments can stay the same for the buyers and remain affordable,” Monjazi says. “A lower sale price due to higher rates also means buyers can more easily afford a down payment.”
The simple economic theory of supply and demand also comes into play.
“As interest rates increase money supply decreases,” says Russab Ali, founder of SMC Digital Marketing who has studied in economics at NYU and has bought multiple properties as an investor. “This is an economic rule that exists because increasing interest rates means banks lend less money so there is a lower supply of money around.
“As money supply decreases, there is less money for investments,” Ali says. “This means investors — who are the majority of people who buy real estate — look for homes that will provide higher returns,” such as cheaper homes.
“When interest rates go up there will be less people who will be able to afford the monthly payment of a mortgage,” says Malcolm Lawson, a real estate agent at Key Partners in Annapolis, Maryland. “This means there will be less buyers in the market in general.”
“For those who still do qualify, the amount that they qualify for may go down, which will lead to them only being able to afford homes at a lower price point than before,” Lawson says.
What is now a seller’s market may turn into a buyer’s market if interest rates rise, he says. “It’s going to make it a lot easier and a lot less stressful for buying a home,” Lawson says.
Instead of home prices dropping, it will most likely mean a lower rate of appreciation, he says, though high-end homes may drop in value.
Other ways to make homes affordable
Homes have been affordable the past five years, despite prices increasing, mainly thanks to low interest rates.
Home prices are exactly where they were at the market peak in 2006, when affordability was at 41.6 percent — near the 41 percent rate in 2015 when affordability hit its lowest rate in the 25 years the National Association of Home Builders has been measuring it.
If the 61.4 percent affordability rate of the third quarter of 2016 is to continue, it won’t be because there are fewer buyers and dropping home prices, says Alisa Glutz, a mortgage banker at Cherry Creek Mortgage in Scottsdale, Ariz.
“I think there is going to be a shift, and people looking closer at other ways to bring these rates down and make it more affordable,” Glutz says.
One option is for buyers to focus more on their credit score so they can qualify for a lower interest rate, she says. Improving a credit score from 679 to 740, for example, can lower an interest rate by 0.75 percent, Glutz says, equating to about $400 less per month for a $250,000 house.
That alone, she says, can make a home a lot more affordable than wondering what the Federal Reserve is going to do with interest rates.