Financial

Why Higher Mortgage Rates May Be Great For The Housing Market

As stocks sell off in part due to higher interest rates, the question now turns to how higher mortgage rates will affect the housing market? You might automatically think higher mortgage rates are negative for the housing market. But let’s look at the other side.

One of the reasons why I like investing in real estate is because it tends to hold its value better. Real estate can be considered a riskier form of capital preservation investment.

A small earnings miss in a high-valuation company tends to crush the company’s share price. Whereas real estate values tend to just chug along, neither explosive on the upside nor downside, in normal times. It’s the classic tortoise versus the hare story.

Just think about what’s happening in the month of January 2022 with stocks. Do you think the national median home price is also down similar levels? Not at all. Seasonally adjusted, the national median home price is probably at the same level or higher than where prices started the year.

As a reminder, my 2022 housing market thesis is that the rate of appreciation will slow from ~16%-19% in 2021 to +8%-10% in 2022. One of the reasons why is due to higher mortgage rates. However, an 8-10% appreciation rate is still great, especially if other asset classes end the year flat to down.

Why Higher Mortgage Rates Could Be Good For The Housing Market

Despite higher mortgage rates acting as a headwind for housing prices, let’s look at some of the positives.

1) Eliminates the marginal buyer and protects the long-term health of the housing market.

One of the reasons why the global financial crisis occurred in 2008-2009 is because borrowers stretched too far to buy a home. With low or no down payments, suboptimal credit, and unreliable income, homebuyers couldn’t hold on in a correction. Lenders were also overly aggressive no doubt.

Higher mortgage rates help take out the froth in the housing market. Higher rates force lenders to scrutinize a mortgage application more closely. Lenders also try to forecast the future. They know that when rates go up, there is incrementally more risk for higher defaults.

Higher mortgage rates also knock out the marginal buyer who violates responsible home buying rules, such as my 30/30/3 rule and net worth buying rule. Fewer marginal buyers help protect other buyers and existing homeowners from experiencing a cascade of short sales and bankruptcies.

For the long-term health of the housing market, higher mortgage rates should improve the incremental quality of the buyer pool. We all know there are plenty of people out there who are stretching to buy property today. This may not be a great move in cities that face a lot of upcoming supply.

2) Gives cashed-up buyers an even better chance to compete.

During a housing market frenzy, you will often have to compete with multiple other buyers. Even if you’ve got strong financials and offer great terms, you might still lose out to a buyer with a higher offer, but who has poor financials. The seller often can’t tell the full financial health of a potential buyer unless the buyer provides documentation.

It’s kind of like how university admissions officers can’t tell an applicant’s full academic strength now that SAT and ACT scores are optional. As a result, applications to more selective universities have skyrocketed. But if you’ve got a high SAT or ACT score, it would be to your advantage to submit your test scores, even if it is optional.

If you are a cashed-up buyer (high SAT/ACT test score), you increase your chances of buying a property due to less marginal competition. Further, you might not have to pay as big of a premium to beat out your competition. This is obviously better for qualified buyers in the long term.

3) Less stress for sellers.

Selling a house is way more stressful than buying a house. If your deal falls through, it’s egg on your face. You will have to re-list and go through the entire marketing and evaluation process again. Some buyers will wonder why escrow fell through, which may adversely affect your asking price. The waiting period for the buyer to perform can be excruciating since anything can and will happen.

When it comes time to sell your house, you might be tempted by a sky-high offer price, even if the buyer doesn’t have strong financials. As a result, you might accept the highest offer price and end up regretting your decision if the buyer can’t get financing in time or at all.

In a frothy market, you may have to wade through a dozen offers. But as mortgage rates rise, there will be fewer, but higher quality competing offers. As a result, you should be more confident about your choices.

4) Higher mortgage rates may boost prices further short-term

Due to the potential for even higher mortgage rates in the future, more buyers might rush to buy property, further pushing up prices short term. This is like Fear Of Missing Out at work, which is often counterproductive.

Remember, you can never change your purchase price, but you can often refinance and change your mortgage rate. Therefore, I encourage you not to rush into buying a home due to the anticipation of even higher mortgage rates in the future. There will always be another great house that comes to market.

The reality is, a 0.5% average increase in the 30-year fixed rate to 3.625% is still dirt cheap compared to historical averages. However, home prices have obviously increased quite a bit since 2012 as well.

I don’t think mortgage rates will increase much further. 4% is likely the ceiling for the average 30-year fixed-rate mortgage this year and probably next year too. Interest rates have been in a down channel since the late 1980s.

5) Rising interest rates are a positive signal for a strong economy.

Interest rates tend to rise in a strong economy. Currently, the labor market and company earnings are strong, which causes inflationary pressure. As a result, interest rates increase to counteract such pressure and the economy cools off. The cycle tends to repeat over and over again.

When the Federal Reserve is aggressively cutting rates and when investors are piling into the safety of treasury bonds, this usually means the economy is weakening. Or, it could mean there is some event that is creating massive uncertainty, e.g. pandemic, war, terrorist attack, bubble bursting, etc.

How Housing Prices Perform When Mortgage Rates Rise

Below is a chart from the Federal Reserve that shows how housing prices have performed after mortgage rates started rising. In each period, housing prices increased. This fact highlights the strength of the overall economy trumps the braking effect of higher mortgage rates for determining housing prices.

A More Normal Market Is Healthy

Unlike buying stocks with a click of a button, buying a property you love is much harder to do. There’s also a lot more emotion involved in buying property as well. Once you identify a property, you’ll often start imagining what your life would be like once you move in. You may already have the paint colors and window coverings in your mind!

As a responsible buyer, you should be pleased with slightly higher mortgage rates from both a short-term and long-term perspective. As a real estate investor, don’t want a repeat of what happened from 2007 – 2010. Instead, you’re looking for steady returns.

As someone who wants to continue to invest in real estate, I welcome a more normal market where I don’t have to compete so hard and pay up so much. In the short term, there may be some market dislocations (and opportunities). But over the long term, higher mortgage rates are good for the overall health of the housing market.

Booms and busts cause too much financial destruction and stress. Ideally, our investments move to the background so we can focus on living our best lives.

Related real estate posts:

Why Real Estate Will Always Be More Attractive Than Stocks

Why The Housing Market Won’t Crash Any Time Soon

Readers, what are your thoughts about higher mortgage rates positively or negatively affecting the housing market? What are some other positives or negatives you can think of? Does the sell-off in stocks and the steadiness of the real estate market make you want to buy stocks or real estate?

Source
Why Higher Mortgage Rates May Be Great For The Housing Market is written by Financial Samurai for www.financialsamurai.com

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