When it comes to the housing market, housing prices, and money for real estate, few things can impact U.S. housing like rising interest rates would. In fact, were it not for the already extreme efforts of the Federal Reserve, interest rates for mortgages in the U.S. would probably be above 6% already.
Spain is getting a taste what out-of-control government debt can do to interest rates in a relatively short period of time. According to an article by associated press reporter Harold Heckle, in the Atlanta Journal and Constitution, Spain’s borrowing costs have escalated above 6% because investors are losing faith in Spain’s ability to control it’s debt problems. This is double their 2005 rate of around 3%, and if this rate were to continue to climb much higher, it could trigger a Spanish default.
Needless to say, this sharp rise in the cost of borrowing will have a very negative impact across the entire Spanish economy, where unemployment is already around 25% officially.
Here in the U.S. the public probably does not share much concern for the Spanish dilemma, since we are not part of the Euro zone, as Spain is, and our interest rates are still near zero. Plus, the dollar enjoys a unique status as the world’s reserve currency, which gives the U.S. government and the Federal Reserve options that no other nation has, when it comes to manipulating interest rates and printing money, or what is known as “Quantitative Easing”.
But it would not surprise me to find that Ben Bernanke wakes up in a cold sweat around 4 AM each night, after having a nightmare about what could happen if the U.S. does not get control of it’s own debt problems. While Mr. Bernanke has repeatedly warned congress that the U.S. is “on an unsustainable trajectory“, everything seems to continue with “business as usual”. But there are forces at work even now, that virtually guarantee that at some point just a few years down the road, we could lose our reserve currency status, and / or lose total control of our ability to manipulate government borrowing costs, which could and would send interest rates escalating upward very quickly.
The collapse of Bear Stearns, in March of 2008 comes to mind. Like the Spanish crisis we are seeing today, everyone argued in March of 2008 about whether the collapse of Bear might mean problems were looming for the mortgage market, and therefore, the broader economy. I wrote an article at that time which said that Bear was heavily involved in bad second mortgages, and that Bear’s collapse was a preview of what was happening to the broader mortgage market. Few experts realized it at the time, but Bear’s collapse proved to be the first indicator of what would become a full blown U.S. banking crisis just 5 months later.
Could Spain prove to be the “Bear Stearns” of Europe? I hope not, but it is very possible. And if Europe has to continue bailing out it’s Eurozone members, it’s just a matter of time before a bigger crisis will unfold.
What would happen if interest rates suddenly began to escalate in the U.S.? Without the Fed’s current ability to manipulate interest rates by printing more money and doing everything they can to keep rates as low as possible, government borrowing costs would soar. This would then mean that FHA, VA, USDA and other government insured loans would also see drastic increases in rates. This of course, would mean that mortgages would be much more expensive, payments would go up, and home prices would likely decline further, as even fewer borrowers would be able to buy a home using traditional financing.
It’s interesting to note that this has already happened. Back in the late 1970’s during the Carter Administration, interest rates began to rise dramatically. By the early 1980’s they were near 20%. This had a severe impact on the cost of a new mortgage. Borrowers who could not qualify for an expensive mortgage with a 15% or 18% interest rate, still wanted to buy a home but even a modest home had a high mortgage payment. Sellers found it very difficult to sell a home due to the lack of qualified borrowers.
As a result, the real estate market adapted to the high interest rates and this situation led to the rise of creative real estate finance, in which investors, buyers and sellers began to seek ways around the problem of high interest rates.
Real estate is an interesting commodity. When food prices go up, people compensate by buying more hot dogs instead of steak. When gas prices go up, people try to stop all their unnecessary driving. But most of us still want a roof over our heads, no matter what is happening with interest rates.
As a result, the high interest rates of the 1980’s drove competition for rental property. The 1980’s was the last time it was “normal” to increase rents by 10% a year and still have multiple applicants vying for the same property. Rising interest rates are not viewed as a good development, but historically, rising interest rates are a boon for rental property owners, who’ve seen very flat or even falling rental rates since the late 1990’s.
Sellers in the 1980’s discovered that they could sell more easily if they allowed a buyer to take over their existing mortgage. In those days you didn’t even have to qualify to take over most existing mortgages. Seller’s who had gotten their mortgage prior to 1972 had very low rates, and in the early 1980’s buyers competed to assume those low interest rate mortgages to avoid getting a new mortgage at 15%.
I do believe, as most ordinary folks do, that it’s a matter of time before interest rates once again begin to rise dramatically in the U.S. If you’re a smart home buyer or real estate investor, you’ll stick with low, fixed rate mortgages now, and avoid adjustable rate mortgages like the plague.
When the market fundamentals begin to change, as when interest rates begin to rise, it’s important to recognize the change and make sure you are in the best possible position to be supported by the fundamentals. Otherwise, the fundamentals can ruin you by leaving you owing more than your property is worth, or holding an adjustable rate mortgage with payments you can’t afford. I’m sure this sounds familiar to many home owners who ignored the fundamentals in 2007 and bought at the peak of the market. In real estate, it’s not a question of a “good” or “bad” market, it’s about the fundamentals and how to use them to your advantage.
When the poop does hit the financial fan, those who have borrowed at today’s low fixed rates will have the upper hand, and rental property owners will see the first real boom in rental property rates since the 1980’s. Real estate has a unique ability to be adaptable to any set of market conditions, because unlike other commodities, shelter is an essential human need. No matter what the market does, no matter where interest rates go, we all will still need a place to live.
Donna S. Robinson is a 16 year veteran of the real estate industry, and a real estate market analyst who specializes in working with real estate investors and investment companies. Her website is www.RealtyBizConsulting.com