The National Association of REALTOR's most recent report on existing home sales shows that roughly 1 in every 8 homes bought and sold this past month were priced above $500,000, and this was not an uncommon month when looking back over the past ten years.
These "upper end" home sales have been supported by historically low interest rates, and you have to wonder how sustainable this segment of the market will be when mortgage interest rates rise.
Mortgage Interest Rates
The following graph shows mortgage interest rates for the past 50+ years. During that period of time, the average rate is roughly 8.5%, while current rates are hovering at just one-half of the long-term average.
Interest rates have not topped 7% since the latter parts of 2002, and they have been above 5% for nearly five years. Imagine the impact on the pool of buyers for high end homes when interest rates return to normal. Or worse, what will happen when the mortgage markets over-correct and shoot above 10%?
Home Affordability Will Decline
I believe that we will soon experience a significant imbalance between people who need to sell an expensive home versus the number of people who can afford to buy them. Consider this.
Right now, if you were in the market to purchase a $700,000 home, you would likely expect to make a down payment of roughly $140,000 and finance the remaining $560,000. If you borrowed the money at the current rate of 4.3%, your monthly principal and interest payment would mean a monthly payment of just under $2,800 using a 30 year amortization schedule.
Now if interest rates return to normal, your monthly payment would shoot up to $4,300. That's an increase of 55%! But imagine if rates were to soar to 10% (a rate no uncommon from 1979 to 1990), your payment would be 77% higher at $4,900 each month.
Whether you consider mortgage interest rates returning to normal or over-correcting to a rate the US market has endured in the past, it doesn't take much of an imagination to consider the impact on the US housing market.
Supply And Demand For High End Homes
The increased cost of money will be devastating to the highest priced homes in most US markets.
The impact will be born on both sellers and buyers.
There has been a very high level of construction of homes priced above $500,000 that are currently occupied by people with low mortgage interest rates. It was not cash buyers who created the surge at this end of the market, rather it was the availability of cheap money that creating the explosion in demand. We have to consider that segment of the demand will disappear when low mortgage interest rates are extinguished.
As rates rise and existing high end homeowners need to move, the imbalance between supply and demand will get worse. Fewer buyers will be able to afford these homes, and thus the inventory will grow.
As sellers begin to far outweigh buyers, pricing pressure will force sellers to drop their asking prices. These high end homes will soon be competing for buyers at lower price points, pushing values at all levels downward.
There will not be enough cash buyers in the market to carry high end homes, so there will be pressure on lenders to develop special loan products to fill the void. Does any of this sound familiar?
Advice For High End Homeowners
If you are happy in your home, stay in it and enjoy it. But if you know that you will be needing to move in the next few years, consider selling your home now while mortgage interest rates are low and the buyer pool is flush with people who can afford to compete for your home.
While it might be inconvenient to move to a temporary housing solution, it could end up saving you hundreds of thousands of dollars. When mortgage interest rates rise, selling a high end home will be like a game of musical chairs, and you don't want to be the one who loses.
About The Author
Joe Manausa, MBA is a 23+ year veteran of real estate brokerage in the State of Florida and has owned or managed his own company since 1992. He writes for the Tallahassee Real Estate Blog featuring content that focuses on real estate analytics for a tactical advantage in today's challenging market.