One of our buyers closed last month with a 3.87% interest rate. We saw many sub-4% loans the past several months, though rates have now climbed back above 4.6%.
Let’s imagine hypothetical first time buyers with a toddler who closed this year with an interest rate below 4%. Fast forward 5 years to 2015 and imagine they now have a 6 year old and a 3 year old. The career is going well, income is up, savings account is healthy, cars and student loans are paid off, the economy is good and the house is starting to feel a bit small.
This is the profile of a typical move-up buyer in Austin. Move-up buyers play an important role in the real estate market by providing resale housing stock for first timers to buy and, simultaneously, providing demand for the mid and upper range homes in Austin. We need this “move-up churn”. It’s good for the real estate market and Austin’s economy.
But now let’s also imagine that in 5 years from now that the best interest rate available on a new mortgage is an unfathomable 6.75%. Don’t think it will go that “high”? That’s not ever a “high” interest rate! And yes, it will get that high again – eventually. How hard will it be for a move-up buyer to let go of that 3.75% loan on the current home? Very hard, I’m going to bet.
I think the psychological urge to hold onto that loan is going to be very strong. And I think it will factor into the move-up decision more than we may currently realize.
We now have a large percentage of the home buying population who’ve never seen an interest rate above 7%. I’m still paying 8% on two loans I have from 2001. I thought 8% was a good rate at the time, for investment property. Historically, for most baby-boomers, anything below 7% or 8% has been a decent interest rate, because those are the rates we’ve always known – up until the mid-2000′s. Now, the “new normal” for interest rates is below 5%.
Moving up from a home with a 4% interest rate to one with a 6 or 7% interest rate creates a different math equation than making the move with an interest-rate-neutral new loan, or as in recent years, getting more house while also dumping a higher interest loan in exchange for one at an historic low rate.
Let’s see how it looks on a chart and how the math worked out for a recent move-up buyer, going from an interest rate in the high 6′s to an interest rate of 4%.
|Recent 2010 Move-up Scenario to Lower Interest Rate|
|Existing Home||Move-up Home||% increase|
|Austin Move-up Buyer Scenario for 2015|
|Existing Home||Move-up Home||% increase|
For our hypothetical 2015 move-up buyer, in order to get a home that is 33% better, the buyer will have to be willing to accept a 75% increase in monthly payment (PITI), and a whopping 104% increase in the principle + interest portion of the payment. That’s almost a $1,000 increase in the monthly payment whereas our 2010 buyer accomplished the same move-up with only a $108 bump in monthly payment. What a contrast.
If I were this future move-up buyer, I’d be comparing a move-up to another option. How about a home remodel with $50K loan at 8% on a 15 year note that will increase the monthly payment by only $478?
Finally, if the belt tightening of Americans continues, and baby boomer go on a housing diet as empty-nesters, more people might be moving down instead of up. Sylvia and I relocated to a smaller, cheaper home in Westlake this year. In doing so, we paid off our $400K loan on the old house which had a 5.95% interest rate and obtained a new $270K loan at 4.75% (we missed that 4% bubble as we locked in last June). Thought we were mostly motivated by getting into the Eanes ISD, the financial effect of the move-down was turbo-charged by the accompanying drop in interest rate. Future move-down people, if leaving behind a 4% interest rate – even on a higher loan amount – will realize less of a budget advantage than we are enjoying.
Of course time will tell, and nothing can be accurately predicted, but I do think those Austin buyers who were fortunate enough to obtain loans at or below 4% are going to covet those loans and find themselves feeling resistance toward doing a trade up such as the one outlined above.