What’s More Important: Home Prices Or Mortgage Rates?
We’re at an interesting stage in the current economic cycle. Rates bottomed out in 2003 and stayed near all-time lows until mid-2004. Since then, rates have been moving up slowly but consistently. This has helped cool the fevered competition and home price appreciation of the past several years. These economic changes may have you concerned, so this month we’re going to sort out what these changes mean – and where the opportunities are now and going forward.
Why Rates Shouldn’t Matter
Rates are often the first thing homebuyers and investors are curious about, but your first questions should always be about the property itself. Can you get the property for a fair price? What is your purpose for buying it, and how long will you keep it? What is the appreciation potential over that period of time?
These questions should come before rate questions because, in most cases, it’s simple to change the rate structure on an existing property when the market permits later on. It would not be so simple to buy that specific property in that specific neighborhood for the same price later on.
This concept is especially relevant right now because we’re currently in a higher rate cycle. So your initial rate may be higher when you acquire the property, but now you know that’s simple to fix. Your real opportunity is in the price of property. Right now, you’ll most likely pay less for that property than you would in a lower rate market.
Why Rates Have Been Rising
The reason is because the upward rate cycle we’re in now is an intentional move by the Federal Reserve to slow down the appreciation of asset prices across the economy – including housing prices.
The purpose of the Fed is to prevent asset price inflation when our economy is in a growth cycle (like we are now), and to stimulate growth when our economy is in a stagnant or recessionary cycle (like we were from 2001-2004). They do this by raising or lowering the Fed Funds Rate. Fed Funds is an overnight bank-to-bank lending rate that we’ll never see as consumers, but it serves as a benchmark that all other rates react to.
Rates represent the cost of money, so when money is cheaper like it was from 2001-2004, housing prices rise. Now that money is more expensive, housing prices and other asset prices are evening out a bit.
Why Rates May Drop In Early-2007
It’s taken 17 consecutive rate hikes since June 2004 for this to start happening, and now that it has, the Fed and the markets have reason to believe that the current Fed Funds Rate tightening cycle is near an end. So the question is: where are rates headed from here?
Standard & Poor’s chief investment strategist Sam Stovall recently released a compelling answer to that question. His research found that after all eight Fed rate hike campaigns since 1971, rates plateau for about 7 months then start dropping again. This average plateau is only 5.5 months if you remove two extreme instances in recent history when the Fed raised only once before easing.
So if we’re nearing the end of the Fed’s current rate hike cycle, this research certainly suggests the possibility of a rate drop in late-2006, early-2007. Most prominent Wall Street economists agree, and justifiably so … it’s a natural part of the economic cycle.
Putting this all together, you can see that economic cycles are not cause for concern. You just need to understand them–or have the right advisor who understands them–so you can make decisions and seize opportunities, whether it’s a great property or a great rate.