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There's a great scene at the end of "Wall Street" where Bud Fox, who has artificially pumped up the price of Blue Star Airline's stock (BST), starts telling all of his broker buddies to dump the stock in order to cause a massive drop in its price. The incomparable John C. McGinley, playing Marv, sums up the mood when he starts calling all of his clients frantically, telling them that they need to "take the money and run on BST."
I chose that scene to start off this month's blog because a very similar scenario is playing out in the housing market right now. Unfortunately, most buyers and sellers don't have Bud Fox standing over their shoulders telling them when to buy and sell. That's where this blog comes in.
Anyone not paying close attention to the housing market may have missed that we are approaching our own "BST Moment." It's getting close to time to get out of BST. By that, I mean that it's probably time to get off the sidelines and buy a home if you've been thinking of buying, and it's time to sell your home if you've been thinking of selling.
Just like BST's stock being manipulated by Bud Fox, interest rates have been manipulated for the last decade by cheap money policies. And the correction in the stock market last week sent a loud and clear message that the cheap money will be over very soon - and so will the historically low interest rates of the last decade. So why do higher interest rates mean that buyers should buy now and sellers should sell now?
Let's start with the easy one first - the buyer who has been kicking around the idea of buying a house but hasn't pulled the trigger yet. Higher interest rates don't just cost the buyer more money over the long haul; higher interest rates reduce a buyer's purchasing power today. Here's a breakdown of the numbers, starting with the current 15-year fixed rate FHA mortgage, with $10K down, at 4.5% for a buyer making a $100K/year. Watch what happens when rates creep up to 6.5%:
Rate: Amount of House You Can Afford to Finance:
4.5% $256,904
5.0% $250,249
5.5% $243,820
6.0% $237,616
6.5% $231,638
Those are some pretty startling numbers. And before you shoot down my assumption about a 2% interest rate increase over the next 12-18 months, know that most economists have already built a 1% increase in rates into their 12-month modeling and are starting to look at the possibility of a 4th rate hike from the Fed this year.
So what does all of this mean for buyers sitting on the sidelines? Not including the increased interest costs over 30 years that come with higher rates, waiting to buy until next year will mean that you are buying less house for the same amount of money - which translates into a lower return on your investment later when you sell your home. It could mean the difference between getting a check at closing and writing one.
Now let's switch to the sellers that are sitting on the sidelines, which is a more complex situation. As we have illustrated, when interest rates rise, buyers' purchasing power gets reduced. That's bad news for the buyer, but it's worse news for the seller, especially if your house is worth more that what an average buyer in your market can afford to finance at 6.5%. Here in the Midwest where I live, the average buyer in my market makes $60K/year, which translates to an average home price of $203,159.
As rates rise, that average home price "sweet spot" - that price range where you have the largest pool of eligible buyers available to buy your home - goes down. Less eligible buyers available to buy your home equates to longer days on market to get the selling price you want from your home, and longer days on market equates to less net return on your investment as you continue to pay your mortgage, taxes and insurance on your home while you try to sell - none of which you recoup in the final sales price of your home.
But you say, wait a minute, housing inventory is tight in my market - doesn't that offset the downside of higher interest rates? Sorry to be the bearer of bad news, but the answer is "no." The math on what lenders will finance on a home is much tighter now than it was before the Great Recession - that's the big difference between what the housing market looked like when interest rates were in the 6's back then and this time around. Steady incomes, debt-to-income ratios and FICO scores actually matter now to lenders. Because of this, buyers will have less purchasing power when interest rates go back to pre-Recession levels than buyers did back in 2006 when nobody was checking the math on loan applications.
Tighter underwriting regs than we have seen in the last two decades, tighter housing inventories and rising interest rates after a decade of historically cheap money - all of this represents an unprecedented paradigm shift in the residential real estate market. But then these are unprecedented times. It's been a wild ride, and like all wild rides, this one's coming to an end. That's why it's time for homebuyers and homeowners to take the money and run on BST.
