I’ve been surprised recently in reading and listening to multiple real estate economists lately that they’re predicting that rising interest rates will slow things down, but that the market should continue to appreciate, just at a more marginal rate.  They’re lying.  Here’s why:

The average home price in the US is now roughly $400,000.  Last year it was in the low $300k range.  What’s been pushing the values up?  A combination of low supply, high construction material costs and low interest rates.  Supply is still relatively low, construction costs are still really high, but interest rates are way higher too.  So assuming the first 2 conditions stay the same, how much impact can interest rates by themselves really have?  A huge impact.  Economists- mostly hired by the Real Estate firms and large real estate organizations in the U.S. want you to believe that the impact will be nominal and that the other pressures will carry the day.  Here’s why they won’t and they can’t.

In 2021, a first time home buyer going to buy and average home, likely would have gotten a 30 year fixed rate mortgage of roughly $290,000 (5% down, conventional) at an interest rate of roughly 2.5%.   The principal and interest portion of this payment was $1144/month.  On top of that most lenders would escrow property taxes and insurance, probably making the payment closer to $1500/mo. 

Fast forward to 2022, average home prices are up to almost $400k.  An average 5% down loan is now roughly $380k.  Even if interest rates were the same at 2.5%, that’s an increased monthly payment to $1501/month before T&I.  But interest rates aren’t the same, they’re already over 5% and expected to hit 6.5% this year.  A $380k loan at 6.5% interest is a monthly payment of $2401/month and when you add T&I, you’re probably closer to $3k/month, about $36k/year… for an average home.  While home prices increased by about 20-30%, payments will have increased well over 100% during the same period.   

Now look at the median household income nationwide, of $74,096 so far in 2022.  In Idaho it’s under $56k, in Pocatello, Idaho it’s about $46k per year.    At the new interest rates, nationwide the PITI (principal, interest, taxes & insurance) payment debt to income ratio is 48.6%.  That’s above what Fanny Mae allows for most borrowers after accounting for all of their other debt.  They usually want the mortgage % to be 36% or less.  In Pocatello, ID, however that’s over a 78% debt to income ratio.  Not even a loan shark that does their business with baseball bats in dark alleys would consider that loan. 

But what about all the equity that people have in their homes- will this not help keep home prices higher?  No, because a lot of that equity is going to disappear soon.  1^st time homebuyers don’t have this equity to play with, they usually have cash in a bank account they’ve been saving.  For them, interest rates matter the most because the down payment is lower than those transferring equity, meaning a higher loan amount and a higher correlating mortgage payment.  If the first-time home buyers can’t afford to buy at the higher prices, then who starts the buying cycle?  Hedge funds?  Affordability is going to hit the bottom end of the market the hardest and that will be the weight that pulls the rest of the market way down as equity positions shrink in the tiers above them to compensate and keep things moving. 

Unless wages magically increase by 100% + margins, which they can’t, because businesses don’t have the profit margins to compensate for it, there is simply no way to sustain the higher market prices, especially in lower income regions.  It doesn’t matter what construction costs are or if home supplies have 100 homes or 5 homes available in your neighborhood, if you can’t afford any of them, you won’t be buying.  That’s the impact of the higher interest rates.

Why are economists trying to downplay this?  The only explanation can be that they are desperately trying to keep real estate transactions flowing.  You’ve now seen the math…consider yourself warned.  Either consider renting this year or be very cautious on buying.  If you buy, plan to stay in your purchase for a least 5 years.  When buying any real estate- always let the numbers dictate how much, when and where to buy.  Numbers don’t have opinions, only humans do.