Interest Rates Are Up, Now What?
By Mercedes Shaffer l Published In AOA Magazine
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During the pandemic interest rates were at an all-time low with many property owners locking in a 30-year fixed-rate mortgages at a 2 - 2.5% interest rate. Exceptionally low interest rates combined with historically low inventory contributed to the real estate market in California appreciating at an average rate of 20% year-over-year.
The housing market has been way too overheated and now the Feds are trying to slow it down by increasing interest rates, so from the beginning of March to the end of April rates went up from 3% to 5.25% for single family homes and rates went as high as 5.5% plus 1 ¼ points for multifamily, which marked the fastest spike in interest rates since 1994.
Historical Trends With Interest Rates
In 2013 we saw interest rates go from 3.5% to 4.5% in the span of one year, and as a result in California we saw inventory grow from just under 25,000 active listings at the beginning of the year to almost 40,000 active listings by November. When interest rates went up in 2013, affordability went down, buyers backed off and inventory rose. Currently we have just under 15,000 active listings in California and just like in 2013, inventory is going to rise if interest rates hold and especially if interest rates continue to go up as the Fed indicate they plan on approving six more interest rate hikes before the end of the year.
The increase in interest rates in April created an abrupt decrease in demand throughout California. We had 16,052 pending home sales in CA in April, compared with 19,308 pending homes at the exact same time last year. Typically, April is the start of the Spring selling season where we see an increase in buyer demand that is met with an increase in homes available on the market and pending home sales usually rise at a rate of 3%. This increased demand often continues until early summer and peaks in mid to late June. Instead, what we’re seeing is that demand peaked in March, with pending sales trending down following the increase in interest rates. The pending sales in April was the lowest level recorded for this time of year since tracking began in California in 2012.
The only exception was April of 2020, during the start of the COVID pandemic when everything was shut down and no one could look at homes. Once the real estate industry was given the green light and deemed an essential business, the flood gates opened, buyers were hungry to purchase real estate, and bidding wars became the norm.
The active listing inventory in California went up to 14,450 homes in mid-April which was an increase of 787 homes compared to md-March. This is the largest increase in inventory that we’ve seen this year. Last year at this exact same time there were 16,259 homes on the market and the 3-year average prior to COVID there were 36,542 active listings on the market. While inventory is trending up, it’s important to keep in mind that it is still the lowest it has ever been. So even with decreased demand, real estate prices will continue to go up, it will just be at a slower pace than the previous years when interest rates were much lower.
How Interest Rates Impact Affordability
If a family wants a mortgage payment of $4,000 per month, and interest rates are at 3%, they can purchase a $1,0544,444 home (mortgage payment is principal and interest with a 10% down payment.) If interest rates are 5.5%, they can afford a $782,222 home, that’s a $272,222 difference!
Because we still have historically low inventory, even though interest rates have gone up, home values will continue to rise, making home buying even less affordable for someone on a fixed budget. We are still in a hot Seller’s market, it’s just starting to slightly cool down from the EXTREMELY hot Seller’s market we’ve had for the past two years.
Who This Impacts The Most
Interest rates have pushed some buyers out of the market. Home prices keep rising, and now interest rates make it more expensive, so some buyers are leaving the market because they can’t find what they like at a lower price point. The first buyers to leave the market when interest rates went up were entry level buyers.
Those who had qualified for a 3% fixed rate mortgage at the beginning of the year and were still in the market looking for a home in April when rates rose dramatically, didn’t have additional money for a higher down payment to offset the higher interest rate, nor did they have extra money to be able to afford the higher payment. As a result, their buying power dropped significantly and suddenly the home that they could afford was a big downgrade from what they were looking at when they first embarked on their home search.
First time buyers are also competing with a large numbers of down-sizing Baby Boomers for entry level homes, and oftentimes the Baby Boomers can pay all cash due to the equity they built up in their previous home that they likely just sold, or at least they can afford a very large down payment, which make them stronger buyers and less vulnerable to the changing interest rates.
Even with higher interest rates, there will still be buyers and sellers, it will just be more muted. The market doesn’t change in a snap. We currently have 22,092 fewer homes on the market in California compared to the 3-year average prior to COVID, and prior to COVID it was still a seller’s market with homes appreciating at a steady rate of 5% per year.
The news is full of headlines about the real estate market bubble bursting, as though all of a sudden real estate prices are going to tumble and it will be a Buyers’ market. People are wondering when prices are going to plunge, but they won’t be going down anytime soon in California, they just won’t be going up at the same rate they were when interest rates were 2%. On the other hand, with many entry-level first-time buyers being pushed out of the market, those would-be-buyers will now be renters, creating even greater demand for rental housing.