Expectations for mortgage interest rates

By: J. David Chapman/January 21, 2021

Interest rates have been the favored government economic manipulation tool over the years in response to various man-made and natural economic disturbances. The reason? It appears to work. Particularly, the real estate market responds to low interest rates, thereby spurring property sales and increasing real estate prices.

There is some indication that a Biden presidency will see an increase in mortgage rates. Long-term bond yields influence interest rates on mortgages and other consumer loans. These long-term bond yields are climbing amid expectations of higher U.S. government spending on pandemic relief and economic recovery efforts.

Economists are predicting modest mortgage rate rises this year. In my opinion, this increase is unlikely to derail the red-hot housing market. It might cause a few “payment-seeking” consumers to settle for smaller, less expensive homes, but the Fed’s reliance on interest rates to control the economy will prevent significant changes – the market will not tolerate excessive changes at this time and they realize it.

I have always had a contrary viewpoint on interest-rate manipulation from governments. Because I’ve studied correlations of interest rates, property values, and market conditions, I have built a business that is less dependent upon interest-rate fluctuations. While the low-interest mortgage rate conditions help homebuilders, lenders, and real estate professionals, I doubt they actually help consumers much in the long run.

Interest rates are only important if the buyer carries a mortgage on the property. This is obvious. However, what might not be as obvious is the average length of time that mortgage-holders actually hold the mortgage. The average is around four years before either refinancing the loan or settling the mortgage to sell the property.

What we do know is that property prices increase during low-interest rate environments and the effect it is having on affordability. As of November, sales of previously owned homes were nearly 26% higher than a year earlier, according to the National Association of Realtors. This permanently increases the price-basis a consumer has in the property. Keep in mind that a consumer can always refinance a worse-than-market interest rate or pay off a loan, but the price they pay for the asset is permanent. Maybe we should focus more on the effect that low-interest rates have on affordability and less on the rate itself.

J. David Chapman is an associate professor of finance and real estate at the University of Central Oklahoma (jchapman7@uco.edu).