Rising Mortgage Rates

2013-07-07 YTD Mortgage RatesAs those actively looking for a home can tell you, mortgage rates have risen sharply in the past two months. The chart to the right shows the average rate for a 30-year fixed-rate loan since the beginning of the year. The chart is from the Bankrate.com site.

From January through the beginning of May, mortgage interest rates bounced around the 3.5% level. But then, over the course of a little more than a month they increased to over 4.5%.

Buyers have been impacted by the change in a few different ways. Some chose not to lock their rate when they got a home under contract in the spring market, which unfortunately didn’t work out well for them. Others were surprised to be impacted. I know of one case where the buyer’s rate lock lapsed when a closing was delayed and their rate adjusted upwards by a meaningful amount, which also forced them to accept a 3 day waiting period associated with the lender’s required disclosures.

But taking a step back, what should buyers think about rates at 4.5%? The reality of the situation is that from a historical perspective mortgage rates are still very attractive. Have a look at this chart, which is based on National Average Contract Mortgage Rate data since January 1990 from the mortgage-x.com site.

2013-07-07 Mortgage Rates Since 1990

This chart ends with the May 2013 data point, so it doesn’t show the recent uptick. But still … 4.5% is lower than everything on this chart before the fourth quarter of 2010.

Another way to look at this is by quantifying the impact of the rate increase. Consider a $300,000 home that someone is buying with a 30-year loan and 10% down. Seeing the rate jump from 3.5% to 4.5% causes the monthly principal and interest payment to increase by $156 from $1,212 to $1,368. $156 per month is $1,868 per year, which does not radically change a buyer’s financial equation, but is not an insignificant amount of money either.

The big question about the current interest rate trend is this – how will the real estate market be impacted? Rising rates reduce a buyer’s purchasing power – will this scare some buyers away and force others to reduce their offers? Or will fear of rates rising even higher force buyers off the fence and actually increase demand for real estate?

Bill McBride, author of an economics site called Calculated Risk, has written about the relationship between housing prices and mortgage rates a couple times. In his first piece he noted that the negative impact of rising interest rated is overshadowed by other factors, like the positive impact of a strengthening economy. Most recently he looked at example time periods when the economy was growing at the same time mortgage rates were rising. He found this supported his conclusion that rising rates may slow price gains, but are unlikely to cause home prices to fall.

If you are considering a home purchase, how are you thinking about the rising mortgage rates?

Killing the Mortgage Interest Tax Deduction

Reflections at MDC Reservoir 6Speculating that the mortgage interest tax deduction might go away is currently quite popular. News sites all across the internet have taken various angles on what it might mean to individual homeowners and the real estate markets in general.

Most articles argue that eliminating this tax break will cause home values to decrease. The National Association of Realtors is frequently quoted as estimating that home prices would fall by 15% nationally and more in areas with higher prices (like Connecticut). The second most common angle is arguing about who actually benefits most from the tax credit – the “1%” or the “middle class.”

We have three observations:

First, nobody knows exactly how eliminating the tax credit for mortgage interest will impact the housing markets. It’s something that has never happened before in the US, so we can’t look back and see what happened last time. This post on The Big Picture blog is the most succinct summary of the history of the mortgage interest tax deduction that I have found, and has some references at the bottom.

We believe any market, real estate or otherwise, is far too complicated to model with any accuracy. So trying to put a number on the impact of one minor change in the dynamics of the market is unproductive since it’s almost certainly going to be wrong.

That said, we agree that no longer giving homeowners a tax break will tend to push prices in the downward direction. Taxes are an annual cash expense for homeowners, and this could make expenses go up. But there’s no way to quantify how much of an impact annual operating expenses will have on buyers.

Second, our impression is that home buyers are not focused on the tax credit they’ll get from their mortgage interest when they buy a home. We work with buyers all the time and don’t hear them trying to quantify their tax break and figure that into their bids. Most probably know that there is a tax benefit to owning real estate, but it seems like a vague notion rather than a hard dollar amount.

Finally, the value of the mortgage interest tax deduction has decreased dramatically in recent years. Part of it has to do with the decline in property values. Lower prices mean smaller mortgages and less mortgage interest. But the more important factor is the historically low interest rates. It’s common for qualified buyers to have mortgage rates below 4% these days. And many have refinanced into shorter loan terms with even lower rates that have meaningfully less mortgage interest.

For example, a 30-year fixed-rate loan at 6.25% in 2004 (our first mortgage) had annual interest of about $15,000. That same loan today at more like 3.50% would only have $8,300 in annual interest. So the rate environment alone accounts for a more than 40% reduction in the tax deduction.

The decrease can be even more depending on the choices you make. Falling rates have allowed us to refinance multiple times, and annual interest on our current loan is less than $6,000 per year. It’s the same house, with a slightly lower principal balance, a much lower interest rate, a shorter mortgage term, and a higher monthly payment. So the market, combined with our personal choices, has reduced our mortgage interest tax deduction by about 60% since 2004.

The residential real estate market will continue to exist and function whether mortgage interest is tax deductible or not; people will still need to buy and sell homes. Changing the rules of the game will always have an impact, but it is impossible to quantify just how much one factor will influence how buyers bid for homes. It’s fine to want this particular program to continue – we all want to minimize our taxes/expenses. But it feels like most are overstating the importance of the mortgage interest tax deduction by suggesting killing it off could ruin the recovering housing market.

Interest in Landlording

Landlords are required to follow rules while handling the money of their tenants. One of them relates to the security deposits that they collect when someone first moves in. Tenants are supposed to earn interest on their deposits at a rate defined by the state.

Not for Sale - But a Nice Looking Multi-FamilyFor many years (since 2002) the state held the required security deposit interest rate at 1.5%. This page on the CT Department of Banking site shows the historical interest rates for a wide variety of deposits held in the state of Connecticut. As most everyone knows, it’s been really tough to find a 1.5% interest rate for deposits over the past few years. So landlords have been out of pocket each year to make up the difference. It’s not like it’s a huge amount, the entire 1.5% on a $3,000 security deposit would be $45, but still.

The state reduced the rate dramatically in 2012 to 0.16%. This is more in line with the current interest rate environment, so in that sense it’s long overdue. That same $3,000 security deposit will now only earn $4.80 per year.

But the bigger question is whether or not your landlord is actually paying interest. We would hope that the larger, professional organizations know about the law and comply with it. But the mom-and-pop landlords may not actually know what they’re supposed to be doing. We’re frequently surprised at how fast and loose some landlords seem to run their businesses.

Keeping up with the various rules regarding landlording was one of the main reasons we exited the business after only two years. It really is a commitment to do it right, and for us to be renting a single unit just didn’t make sense. We could see how it would be different if we made that our full-time job, or hired out the management to professionals, but neither of those options were right for us.

It’s actually a good time to be a multi-family property buyer right now. Prices are down overall, and in the more urban towns there are plenty of opportunities for distressed buildings. Many need a cash investment to bring them up to rentable condition, but that’s part of the reason they’re so cheap. People with cash to invest (and who want to earn more than the 0.1% the banks offer) may want to consider real estate. But keep in mind that it’s a tough business that will require time and attention.

Mortgage Rates are Low

Mortgage rates are currently low. Very low.

It’s common for well qualified buyers to get rates below 5%, and we’ve heard of some rates as low as 4.25% on 30-year fixed mortgages with no points. We even saw a sign by the road advertising a 3.99% rate, though it was not clear what the other terms would be.

Here’s a chart from Mortgage-X.com showing rates going back to 1963, which is further than other charts we’ve seen.
Contract Mortgage Rates since 1963 (Mortgage-X.com)
Reproduced with the permission of Mortgage-X.com


Our Thoughts on Low Mortgage Rates

1. People shouldn’t buy houses because mortgage rates are low. Buying a home is a big commitment of time and money, so homeowners need to be in it for the right reasons. Securing a low mortgage rate might be a nice bonus, but it should not be used to justify a purchase – you need to want to own a home.

2. Those in the market for a new home can take advantage of the low rates in different ways. One option is to pay less each month for the same home they would have bought no matter what the rates. Another option is to get a more expensive home for the same monthly payment they would have had before rates fell so low. Finally, they could get a shorter loan (15-years or 20-years instead of 30-years) so that they can build equity faster and pay dramatically less interest overall.

3. Existing home owners may want to consider refinancing their current mortgage. There have been a couple articles recently (CNN, Wall Street Journal) about how refinancings are on the rise again, but that many buyers can’t take advantage because of strict lending requirements (their credit is too poor) and appraisal values (their home values have fallen and they don’t have enough equity).

4. Will rates go even lower? Nobody knows. At some point mortgage rates really can’t go any lower. The two primary inputs into the rates are the interest rate of the 10-year Treasury Bond and the spread above the Treasury that lenders/investors demand. The 10-year Treasury finished yesterday at 2.64%, which is very low from a historical perspective, but it’s possible it could go even lower.

As always, the place to start with everything mortgage-related is with a mortgage professional. They’ll be able to evaluate your specific situation to let you know which options are available to you. We would be happy to pass on the names of mortgage people we’ve used if anyone is interested.