Now that interest rates have risen from the 3.5% range to the 7% range, will home prices decline to balance out the purchasing power?
Looking at historical evidence, it shows that sharply rising mortgage rates tend to slow home price appreciation and affect housing market activity. However, nominal price appreciation in most of Colorado remains positive. During previous times in which interest rates increased, we never had such a housing shortage like we do now. Therefore, even though housing affordability has been reduced, home prices are unlikely to decline dramatically. As a result, affordability challenges are likely to continue.
In fact, in the example below, prices would have to drop considerably in order to change purchasing power to the extent that rising interest rates have done.
Assuming the following scenario, rates go 7% but the price of a home drops $100,000, from $750,000 to $650,000.
If you bought a $750,000 house with a 20% or $150,000 down payment and a 3.5%, 30-year amortized $600,000 loan, the monthly principal and interest payment would be $2,694.27. Now, let’s say the price of the same house has dropped to $650,000 but the interest rate is now 7%. The 20% down would be $130,000 and the 80% loan would be $520,000 and would have a monthly principal and interest payment of $3,459.57. That is $765.30 more than the old payment, even with a $100,000 drop in price.
Let’s take it to the next level. If the price of the house were to drop to $550,000, the down payment drops to $110,000 and the 80% loan becomes $440,000. At 7%, the $440,000 loan would have a monthly principal and interest payment of $2,927.33. That is still $233.06 a month higher than the purchase at $750,000 at 3.5%.
Bottom line, it would take substantial price drops for the monthly payments to balance out the higher interest rates. Due to the continued lack of housing across the nation, the odds of prices dropping to the magnitude in the example above, due to rates at 7%, is pretty slim. After all, being a Realtor who lived through the 16% mortgage rates of the 1980s,
7% doesn’t look that bad.
In much simpler terms, here is how purchasing power changes for every $1,000 borrowed on a 30-year amortized loan:
- $1,000 30 years 3.5% $4.49 a month
- $1,000 30 years 7.0% $6.65 a month
- $1,000 30 years 16% $13.45 a month
There is no question that as rates rise, a few more homebuyers are taken out of the marketplace. We are already seeing the market adjust with interest rate buydowns, variable rate mortgages, owner financing, and price adjustments. As always, consult your real estate professionals for advice that matches your needs to the market.
By Duane Duggan. Duane has been a Realtor for RE/MAX of Boulder since 1982. Living the life of a Realtor and being immersed in real estate led to the inception of his book, Realtor for Life. For questions, e-mail DuaneDuggan@boulderco.com, call 303.441.5611 or visit BoulderPropertyNetwork.com.