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I am getting very nervous for many of my new homebuyers. As of January, the average home price in Austin is almost $600K according to realtor.com. When I first started selling a unique product line in Elgin, TX about two years ago, I could hardly wrap my head around the idea that I had a 950 square foot home, with two bedrooms, one bath and NO garage selling for $171,000. Today, I am selling that home for $250,000. I call it my condo on grass. Elgin is a tiny little ‘burb about 25 miles from Austin’s city center. For years, the only reason you stopped there was to buy amazing sausages as you drove to or from Houston. Now, it’s one of a few suburbs first-time homebuyers can afford within driving distance of town. So who loses as the fed hikes interest rates? First time homebuyers, minorities, the lower middle-class, recent college graduates, and America in general.
It’s not like we haven’t seen this coming. We’ve been talking about it for months over the water cooler. It’s the right thing to do for the economy, but the impact in real life may be harder than many anticipate. What many folks don’t know, especially first-time homebuyers, is that lenders don’t typically “lock” an interest rate on your loan until about 30 to 60 days before you are set to close on your home. For a resale home, that’s usually fine. You find a home and they lock the rate within days.
But when you are buying a home from a builder, it is frequently many months from the time you write a contract until you are set to close on the home. So what happens when you write a Purchase Agreement in December for a home to close in May? A homebuyer is generally given a “conditional approval” on a home loan based on interest rate averages at the time of the contracting. That means the loan isn’t set until March or April. Frequently, young or lower income homebuyers are already on the cusp of loan approvals when they purchase. The moment the interest rates increase with any significance, they are now disqualified for the loan. According to Reuters:
“The Federal Reserve on Wednesday raised interest rates for the first time since 2018 and laid out an aggressive plan to push borrowing costs to restrictive levels next year in a pivot from battling the coronavirus pandemic to countering the economic risks posed by excessive inflation and the war in Ukraine.
The U.S. central bank’s Federal Open Market Committee kicked off the move to tighten monetary policy with a quarter-percentage-point increase in the target federal funds rate, lifting that key benchmark from the current near-zero level in a step that will ripple through a variety of other rates charged to consumers and businesses.”
Let me tell you what that looks like in a real-world scenario. John and Mary are soooo excited. They have finally scrimped and saved to put together a modest down payment on their first home. They just got married a couple of years ago, they have been renting for years and have their first child. They finally (and I do mean FINALLY) found a home just after Thanksgiving that is small but affordable and a bank has told them they qualify for the loan. They are over the moon. They bring in their parents and friends over the next few months dreaming of the room for their baby, the backyard birthdays and meeting new families just like them to BBQ with. To every building update I send them, they reply with smiley-face emojis and exclamation points. I can almost see their tails wiggle like a puppy. I have done my best to prepare them for the worst, but they never listen because they see the American dream within grasp.
In the next month or two I will have to make some of the worst phone calls. The lender has just picked up their file for the first time in months to prepare it for underwriting. They are plugging in all the numbers and looking to lock the interest rate. I get a call from the lender telling me that John and Mary no longer qualify for the loan as interest rates have spiked and their debt-to-income ratios no longer are in line for the loan program they anticipated. We are two months away from closing on the home John and Mary have been dreaming of for months and it slips through their fingers like dry sand. It is heartbreaking.
In the meantime, in hot areas of the country like Austin, we have seen home prices jump $50,000 overnight. The $250,000 affordable home John and Mary purchased back at Thanksgiving is now $300,000. The dream is literally out of reach. Washington Post has a great write up of the cascading effect this first of many hikes will have:
“Even though much of this is anticipated, when short-term rates rise, there’s going to be a bump in mortgage rates and a bump in the cost of capital — and that will happen immediately,” said Jeffrey Bergstrand, an economics and finance professor at the University of Notre Dame and former economist for the Federal Reserve Bank of Boston. “Some families just won’t be able to afford those higher monthly payments on a new house or a new car. That will reduce the demand for those things and have a slowing effect on the economy.”
I'm glad I refinanced before Biden came into office.
— TuPakalolo (@BiggerBraddah) March 16, 2022
I can’t prove a negative, but I am just so angry because I believe much of this was avoidable. We created this crisis with Corona Virus stimulus money that was just a grab bag of porkulous spending! We let loose a monetary windfall creating a butterfly effect that was predictable and then followed up with one bad policy decision after another, like killing the keystone pipeline and choking off investments in oil and gas exploration here in the US. Joe Biden has created an economic nightmare for America as these rate hikes ripple through the economy. MSMBC spells out the needle the Federal Reserve will try to thread:
I know we need to slow the bleeding of inflation. I know it’s the right thing for the Federal Reserve to do. I just wonder how much pain the left can inflict upon those who can afford it least before they wake up to who caused it. FJB.
Featured Image: “Interest Rates” by 401(K) 2013 is marked with CC BY-SA 2.0.
George V says: The folks who stand to lose more are the ones who bought overpriced houses recently and who might, in a few years, need to sell. The interest rate rise will tend to push down home prices and many of these homeowners will be upside down on their mortgage. It’s happened at least twice in my recollection over the past 40 or so years.
370H55V says: Everything you say is true, but only part of the story. Home prices are being pushed up not insignificantly by the entry of Wall Street into ownership of thousands of single-family homes for rental purposes. Couples like John and Mary are no match in bidding for such homes against Black Rock, Vanguard, Cal PERS, and others of their ilk.
But then this is part of the whole “you’ll own nothing and you’ll be happy” strategy promoted by our betters. I would say this would be a good issue for the GOP to campaign on in 2022 and beyond, but sadly, they’re in on it too.
Kevin says: Yes, there have a number of articles recently about hedge funds and other wall street mega billion dollar groups purchasing up vast quantities of single family homes to use as rentals and then holding on to them to re-sell at a hefty profit. There was one article I saw that showed a map of a neighborhood in Ohio and most of the homes were rentals owned by hedge funds. Home ownership has been the primary way for families to gain wealth and in many cases to pass that wealth on to their heirs. I bought my first home in 1992 and I still own it as a rental. The purchase price was $60,000. Similar homes in the neighborhood are now selling for over $500K. There will be a correction in the market like in 2008 and that’s when many people will take a bath from overpaying because of the heated, insane market.
Increased interest rates hurt a lot of people. That’s the point. Inflation is out of control so money today is worth more than money tomorrow. This means that if you can borrow valuable money today at interest rates below the rate of inflation, when you pay it back the value of the money you use to pay it back is lower than the value you borrowed in the first place. It’s like the concept of an interest bearing savings account in reverse.
Example: I just took out a $23,000 loan to buy a used truck at 4% interest. I could have paid cash for it, but it makes sense to take out the loan and use the cash for other things (or save it for when I need to buy a loaf of bread for $100). The inflation rate right now is over double that, quickly approaching double digits. That means that the money I pay next year is worth 9 to 10% less than the money I borrowed. Since I’m only paying 4% interest, the money I spent on the truck is worth 5 to 6% more than the money I’m paying back. The next year, since inflation is year over year, if we maintain this level of inflation (and I’m pretty confident we will at least maintain it), the money I pay back is worth almost 20% less than the money I used to buy the truck, the next year, somewhere around 30% less and so on. By the time I pay the truck off, I’ll have essentially only paid back, maybe 2/3 of the value that I initially borrowed including interest, but I’ll own the truck free and clear.
This encourages people to spend money they don’t have…which raises demand, which increases prices, which accelerates inflation.
Raising interest rates increases the costs of borrowing money which reduces the above pressures. It doesn’t remove them unless you raise interest rates to near the rate of inflation so because of the ridiculous rate of inflation at the moment, they’d have to increase interest rates to 1970’s levels to really have any significant impact; of course a secondary effect would be that they’d basically bring the economy crashing down, so the best they can do is raise them a little bit and hope for the best. Which isn’t going to be enough.
But the point is, the entire goal of raising interest rates is to reduce spending by reducing borrowing. The effect that you lament isn’t an unfortunate side effect…it is the point.
The worst thing about these high levels of inflation is that the effects are going to be long lasting. Even if the government reverses course and eliminates all the policies that led to this disaster, it would take years if not decades to recover, just like it did to recover from the disastrous policies of the ’70’s. Unfortunately and even worse, the current administration and congress show no signs of reversing the terrible policies that have caused this and are even doubling down with even more damaging proposals.
Tighten your seat belts and brace yourselves…we’re in for a bumpy ride for the foreseeable future.
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