How Interest Rates Can Drastically Affect Real Estate Prices
Interest rates can drastically affect real estate prices and the profits you make on your real estate properties, probably more than most people realize. An increase of interest rates of 5% to a more normal historical average of 8% can signify a 27% drop in housing prices to maintain a $1000 monthly mortgage payment!
Many people believe that what has driven the real estate market to today's
high prices is the investment value of properties, just like stocks in the dot
com boom. However, if you ask the average person what started the boom, as in
what exactly is the "investment value" most people won't be able to answer you.
Put fairly simple, housing got affordable quickly because interest rates dropped
substantially and rapidly, to their lowest in decades. Although this is not the
only variable, the reality is that for each 1% interest rates dropped, a person
could afford a lot more mortgage with the same monthly payments, especially when
the interest rates are on the lower side of the spectrum. This has fueled the
real estate market boom. However as the flames burned high, the market has taken
a fire all of its own as speculation too hold.
Looking at an example, a
mortgage payment of $1000/month at an interest rate of 5% amortized over 30
years will allow you to pay a mortgage principal of $186,281.62. If you increase
the interest rate by 1% to 6% and you want to maintain the same monthly payment
of $1000, then you cannot sustain a mortgage of more than $166,791.61. This
makes the mortgage amount you can afford 10.97% less than before. Take a higher
interest rate, a more historically average interest rate of around 8%, now you
can only afford a mortgage of $136,283.49, a significant drop of
26.8%!
We can graph the mortgage affordability based on interest rates
alone. As you can see, the mortgage affordability is affected much more
significantly at first. This is unfortunate for all those people that have been
buying up real estate without really doing the research or working their
numbers, or that are on the edge financially. They will most likely get squeezed
out of the market and cause over zealous fire sales, much like the dot com boom
and bust of 2000.
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Source : http://www.prweb.com/releases/2005/6/prweb251556.htm