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Rate Increases and Buying Power – Spelling It All Out

With news of the election results and cabinet appointments still filling the airwaves, it may have been easy to miss the fact that the Federal Open Market Committee (FOMC),  a rotating 12-person committee led by Janet Yellen, met earlier this week.  Often referred to as simply, “The Fed,” its main function is to serve as the keeper of the Fed Funds Rate.  That is the rate at which banks lend money to each other on an overnight basis and affects what consumers see as the Prime Rate.  It’s that Prime Rate that much of our variable (credit cards, home equity lines, business loans) interest rates are based on.

When the Fed Funds Rate is kept low as has been the case now for the past decade, the Fed is attempting to stimulate economic growth.  When it’s raised, the Fed is trying to promote stability and keep inflation at bay.  This week the group took a step away from stimulus and began the track towards stability.  In addition to raising the current rate by 1/4 point, the Fed, more importantly, has pointed to future increases over the next year.

So – all that said – what does this mean for buyers and sellers of real estate?

It is a common belief that the Fed Funds Rate directly impacts mortgage lending rates.  It’s important to remember there isn’t a direct link between the FOMC’s control of the Fed Funds Rate and prevailing mortgage rates.  In fact, the chart below shows that in the past, the Fed Funds Rate and the average 30-year fixed rate mortgage rate have differed at times considerably.


However, like everything else in economics, everything CAN correlate based on the overall reason one particular indicating rate is increased. When the FOMC’s post-meeting press release is considered to be “positive” on the U.S. economy, mortgage rates tend to rise. Conversely, when the Fed promotes a more negative outlook, mortgage rates tend to fall.  We’ve lived in the latter for an abnormally long time.

Nothing lasts forever.

We’ve been and continue to be at historically low mortgage interest rates for nearly a decade now.  As the economy improves over time, all rates can be expected to normalize so for those sitting on the fence unsure if it’s a good time to jump into the market – Get off the fence fairly soon.  Below you’ll see just how long mortgage rates have been at incredibly low levels and then we’ll discuss what increases in those rates do to directly impact your – or your potential pool of buyer’s – purchasing power.


No one is predicting the 10% rate seen in 1990 anytime soon.  However, anything under 6% is generally considered to be historically low, and we’ve been at or under that benchmark since about 2003.  As rates rise, a standard statistic to remember is for every 1% rise in rates, there is a correlating decrease of 11% in buying power.  Visualizations like the graph below do a great job of illustrating what that means in real dollars.  For instance, if you have the ability to support a $1400 monthly mortgage, all other things being equal, at a 4.5% mortgage rate, you could presumably afford to buy a $340,000 home.  Same $1400 – but now rates have gone up to 6.0% (still considered to be a low rate).  In that case, you can now only set your maximum purchase price at about $290,000.  Fifty thousand dollars worth of home is now out of your buying range.  At $100/square foot you basically have given up a 500 square foot loft, bonus room, man cave or den.


In closing, remember that we are still enjoying incredibly low rates today.  The Stephen Cooley Real Estate Group at Keller Williams is helping educate buyers and sellers everyday on whether NOW is the best time to buy or sell.  The information above is obviously subject to change based on any number of economic factors, but the point we’re trying to get across is that IF you’re seriously considering a move and needed a gently “shove” to help you begin the process – this week’s interest rate changes may have just been it.



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