Rising Interest Rates & Your Plan
A: When it comes to interest rates and the effect of rising borrowing costs on our daily lives, recent history probably carries much more weight than ancient history. In this post I will try to analyze the psychology behind a 'more expensive' world in the hopes of finding the best way to invest in it.
Ancient History will tell us that borrowing costs are still 'historically low' and that even if 30YR fixed rates climb above 7% we should be just fine. On the other hand, recent history tells us that those who locked in 30YR fixed did a very wise move!
Lets take a fictional property that sold for $520K 3 years ago compared to the same property that is asking $550K today with rates higher (the market slowdown started around June of 2005 so 3 years ago asking prices and lending rates were lower). Lets also assume the fictional buyer puts 20% down:
3 YEARS AGO $520K - $104K Down Payment (30YR Fixed @ 5.10%):
Monthly Mortgage Payment = $2,258.67
TODAY $550 - $110K Down Payment (30YR Fixed @ 6.375%):
Monthly Mortgage Payment = $2,746.47
Hmm...yea...interesting..the monthly payment for today seems kind of expensive compared to 3 years ago. It seems that RECENT HISTORY is more painful financially than something that happened 30 years ago! Heck, I'm only 30 years old why should I care if mortgage rates right now are still historically low? They certainly are a lot higher than they were a few years ago and will only continue to rise slowly over the next 12 months (since fed rate hikes take time to funnel down the economic system). By this time next year I wouldnt be surprised if 30YR fixed interest rates are around 7.25% - 7.5% or so (unless something unexpected happens that would cause the fed to lower rates).
But forget housing for now and lets consider credit card debt. Whether you know it or not all of these fed rate hikes actually do end up having a negative impact on all that debt you piled onto those Capital One cards! According to Sun-Sentinel.com:
Credit card debt is usually the most expensive kind of household debt, which is especially tough for consumers when interest rates are heading up. "Card rates are rising faster than the rise in general interest rates," said Justin McHenry, research director of the Cleveland-based survey firm.What psychological affect will this have on people once they realize that they are living in a more expensive world? Did your minimium required payment increase in the past year (assuming your spending vs. payoff rate remained constant)? I'm betting it did!The higher interest rates will add a few dollars to minimum monthly payments. But over time, that can add hundreds of dollars to consumers' debt loads. Interest rate hikes can actually sneak up on consumers. That's because most credit cards in use today carry variable rates, which card companies can change without notifying customers in advance.
If your housing + credit expenses have risen over the past few years than chances are you will be forced to sacrifice the luxuries in life that you may have gotton used to such as dinners out or weekend getaways.
FACT IS: Rising Interest Rates affect more than just housing! Here's how I view it:
BORROWING/LIVING COSTS GET MORE EXPENSIVE --> PEOPLE HAVE LESS MONEY TO SAVE/SPEND ---> PEOPLE TIGHTEN SPENDING ---> CONSUMER DEMAND EASES ---> INFLATION STAYS IN CHECK/CORRECTS
WHEN IT COMES TO INVESTING IN HOUSING: Use the philosophy of 'If you can afford it, than find the deal and buy it". NYC Rents are rising to levels that in my opinion makes buying much more attractive. Plus rental inventory is so tight now (NYC Vacancy Rate at 0.89%!) that people are settling, instead of getting something they truly like. If you have a secure job w/ sufficient salary (see Brady's post on What Co-op Board's Look For), good credit, sufficient liquid assets, and a 3+ YR timeline to live there than BUY NOW! It is still a buyers market and there are deals out there. If you wait to buy for another year or so you will also have to hope that asking prices across Manhattan come down to compensate for higher interest rates (cause there going up!).
REMEMBER: With real estate you are being forced to save by building equity, you are entitled to tax benefits when you file your return and on gains when you sell, and you can live in and upgrade your investment!
If you plan to sell in 2 years or less now may not be the best time to be buying. I'm still flat to down on the NYC housing market for the short term and wouldn't be surprised if it remains that way the next few years. The only reason to buy now with a 2YR timeline to sell is if you find a deal that can't be missed!
IF YOU DON'T HAVE ENOUGH MONEY NOW: Be smart. Sacrifice living style and do what you can to get the lowest rental possible so that you can put the extra money AWAY in a money market account or CD. Interest rates are getting to very attractive levels these days with most 1YR CD's at or above 5.00% (WorldBank has 5-month CD at 5.01%). As much as it pains me to say this, tighten your spending habits and get used to budgeting for the next 1-2 years so that you can instead put away an extra few hundred dollars a month or use it to pay down credit debt quicker.
What you are doing is preparing yourself financially for your future investment of buying NYC real estate. By correcting your credit you will be able to get a better rate and save thousands over the term of the loan. By cutting back spending you are hopefully saving more and building up your liquid assets (Cash, Stocks, Bonds, CD's, Money Markets, etc.). After a few years both your credit score and net worth will be higher and you will be ready to afford a down payment without crippling your cash reserves!
Good Luck!
Comments (2)
True that!
Posted by hilton | April 21, 2006 1:49 AM
This article is very useful for everyone that is planing to take a loan from banks or from any financial portal. Interest rates are very important topic of concern and it is dealt here in detail.
Posted by Personal Loans | June 24, 2008 8:00 AM