Real Estate Info for Salt Lake & Davis County

There is a good deal of discussion regarding the current status of the real estate market. Has the market bottomed? Have inventory levels stabilized? What impact will foreclosures and short sales have on absorption rates going forward? Along with the always popular, what are interest rates doing?

I recently had a conversation with a buyer client who expressed his perspective that our current market hasn’t yet "bottomed" and that there may be another 5% of downward price correction still to occur. After our conversation, I decided to run some numbers (yes, I’m a devout data geek) and see what the correlation to further price erosion relative to upward pressure on interest rates as the economy begins to recover. This is with the understanding it will be tough for rates to decline further with the current discount rate at 0.75% - it was at its lowest point of 0.50% a few months ago.

So, I did a quick spreadsheet evaluating a buyer’s "purchasing power" at various combinations of interest rates, down payments, and monthly payment amounts. I found some very interesting data elements that I thought others might like as well.

My first step was to determine the impact of interest rates on loan amounts assuming a constant monthly payment. The underlying logic being that if a buyer budgets for a say a $1,750 monthly principal and interest payment the amount the buyer is able to borrow for that monthly figure will decline as interest rates increase (quite a shock, eh?).

As expected, the amount of the loan, at specific monthly principal and interest payment amounts, dropped as interest rates increased. Not surprisingly, the bigger percentage drops occurred at the lower interest rate levels as a half point increase has a larger percentage impact to the base rate (math 101 on display here). OK, this wasn't the interesting part.

What get’s interesting (and not necessarily in a good way) is the impact small changes in interest rates can have on a buyer’s purchasing power. For example, let’s go back and see what happens to that buyer who wants to keep their monthly principal and interest payment at $1,750. If they are putting 10% down and the current interest rate is 5%, that $1,750 would equate to an estimated purchase price of $362,214.

However, if rates were to increase just 1%, all things being equal, the buyer can now only purchase a property with an estimated price of $324,217. That's a 10.5% drop in purchasing power based on just a 1% change in interest rates! If, in that same timeframe, average prices drop by the 5% estimated by my client, the “new” purchase price for that property would be $344,103. Ouch!!!!

So, IF the average price drops further but interest rates climb slightly, my buyer would no longer be able to purchase his targeted home without bringing more money to the table in terms of down payment. This doesn’t even address the differences in the “types” of homes which could be purchased for $362,000 versus $324,000 in any given market. What this simple exercise does is to reaffirm there is a significant “opportunity cost” for buyers who do not take advantage of the historically low interest rates currently available, especially when housing inventories are at such high levels in most of the country. This analysis also doesn’t factor in tax impacts or lifestyle impacts which should also be considered by buyers.

For those too young to remember what interest rates are capable of reaching, here is a quick history lesson in graphic detail (may be too intense for younger audiences). Given the Fed's immense concern about hyper-inflation should the economy begin to turn around (with all the excess money that has been injected into the economy to create the rebound), it is not unfathomable for us to see interest rates above 6% (which simply puts us back to where things were prior to the financial meltdown).

What this boils down to is advice I give to many of my buyer clients, don't miss out on a very good deal while chasing the "best" deal.  You may be sorry you did.