See How Home Purchasing Power Is Eroding Thanks to Higher Rates and Prices

October 24, 2018
See How Home Purchasing Power Is Eroding Thanks to Higher Rates and Prices

It’s no secret that residential real estate is expensive right now, at least relative to where it stood just a few short years ago.

Home prices have moved higher and higher for about five straight years since bottoming out post-Great Recession, and now prospective buyers have to contend with rising interest rates too.

Just over the past year, this combination of higher mortgage rates and home prices has increased potential housing costs by hundreds of dollars a month in certain locales.

For example, those looking to buy in Portland, Oregon have seen monthly costs go up more than $300, while Boston buyers have seen costs go up around $225.

This is leading to more migration in expensive cities throughout the country. Those in San Francisco are looking at Sacramento instead, and folks in LA are considering moving south to San Diego.

Today's Rates

Sadly, there’s no letup expected in 2019 either. Both home prices and mortgage rates are expected to continue their ascent, albeit at a more muted pace.

Still, much of the damage is already done. And it means either slashing your budget or getting creative to ensure you can afford your dream home.

[10 Ways to Save Money on Your Next Mortgage]

Rates Go Up, Purchasing Power Goes Down

purchase power

As you can see from this nifty graphic from Redfin, as mortgage interest rates increase, potential purchasing power falls.

For example, with rates at 4%, someone who could afford a $3,500 housing payment could buy a $663,250 home, assuming they made a 20% down payment and paid property taxes (1.25%) and homeowners insurance (annual premium roughly 0.5% of property value).

If rates were to increase to 4.5%, their max purchase price then falls to $635,000. At a 5% rate, they’re now closer to a max price of $600,000. And on and on.

Similar examples are illustrated above and none of them seem to bode well for home prices moving forward.

However, it doesn’t always work that way. As I’ve mentioned countless times, mortgage rates and home prices don’t correlate negatively.

That is to say if one goes up, the other doesn’t go down. You might expect home prices to fall if interest rates rise, but history would tell you otherwise.

This simply means that those looking to score a bargain thanks to rising rates might just miss out entirely.

Or that they’ll simply be priced out of the market and have to look for a cheaper home to buy. Or perhaps even go the condo route if the single-family home is too pricey.

Buy Before Rates Rise, Or Wait Until Prices Fall?

  • Prospective home buyers are now facing a quandary
  • Do they buy now and lock in a low interest rate
  • Or wait for home prices to fall because of eroding purchasing power…
  • You can always refinance your mortgage but you can’t change the price you paid for a home

Then we have the catch-22 that is beginning to materialize in this somewhat mature seller’s market.

Today’s prospective buyers have to decide to if they should buy now and lock in a lower mortgage rate, or stay on the sidelines and wait for home prices to fall due to higher rates.

This is if rates actually continue to rise like many expect them to.

But as I just said, home prices may not fall just because rates go up. So this latter strategy could prove to be pretty unsuccessful. It could even lead to the buyer getting hit twice if they chase the house after waiting around.

Redfin doesn’t forecast home prices falling next year in most markets, though the company’s chief economist Daryl Fairweather did note that while home prices declines are typically seen every fall and winter, this year’s have been more extreme.

That could point to weaker home price gains next year, and potentially a shift from seller’s market to buyer’s market.

But it will depend on the market in question. And I still believe we’ll see a strong spring buying season in most markets, especially with the threat of even higher mortgage rates on the horizon.

Read more: Allow Me to Introduce You to the 5% Mortgage Rate


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