Interest Rates Are Ticking Up
For the past forty years, interest rates have been on a fairly steady downward trajectory. Rock bottom rates over the last 18 months, in particular, have undoubtedly helped fuel the recent housing boom. The lower rates mean lower monthly payments, which means more potential buyers qualify and those who do qualify are able to afford larger loans. More buyers who can afford to take on larger mortgages is a formula for higher prices, which is exactly what has happened.
Just how much of a difference do interest rates make? Consider this: the monthly payment on a $250,000 loan with a 30-year fixed rate and a 3.00% interest rate is $1,054/month. That same loan with a 6.00% interest rate? The payment is $1,499/month. Or you can look at the inverse and consider the fact that this same payment of $1,499/month would support a mortgage of $355,000 at a 3.00% interest rate, which means that the difference of three percent means a difference in over $100,000 of property value.
Older Americans likely remember (and younger homebuyers and real estate investors may have vague recollections of hearing their parents, grandparents, or economics professors talking about) high interest rates in the early 1980s, but the actual numbers are pretty staggering especially in the context of today’s comparatively low rates. Exactly 40 years ago in October 1981 the average interest rate on a 30-year fixed mortgage was 18.45%! Interestingly enough, that specific month was the high-water mark as rates eased down from there, although rates remained mostly in the double digits for the next eight years. Even for most of the 1990s rates were between 7.00-9.00% and were as high as 6.00% in the depths of the Great Recession.
The chart below shows the average interest rate on a 30-year fixed mortgage throughout the United States. It illustrates just how high rates were in the early 1980s, and how steadily they have dropped in the decades since (the grey areas are periods of time the economy was in a recession):
So, what’s happening now? Well, by any metric interest rates for home loans are still at historically low levels. According to Bankrate.com, which keeps track of such things, the average interest rate nationwide on a 30-year fixed mortgage as of October 27th was 3.24%.
It is my opinion, however, that rates are on their way up. The bottom has passed. Yes, the current 3.24% interest rate is something homebuyers in earlier times would have drooled over, but rates have actually ticked up four weeks in a row from an average rate of 3.03% on September 1st to this week’s average rate of 3.24%. A shift from 3.03% to 3.24% might not seem like much, but in such a short-time frame it is actually a pretty notable jump. I don’t have data on rates for auto loans, credit cards, or commercial loans, but it is likely that these rates are also starting to tick up. I can say from my perspective as a commercial lender that rates are, indeed, starting to point upward.
Interest rates are largely driven by the actions of the Federal Reserve, which I’ve written about in the past. The Fed is tasked with promoting full employment but also managing inflation, and although employment figures are not as strong as policymakers would like them to be, inflation has proven to be more robust than analysts previously hoped or predicted (it is currently running 4-6% on an annualized basis). So now to cool things down a bit, ease inflationary pressures, and bring prices back to more of an equilibrium or at least to the Fed’s target rate of ordinary inflation of 2% per year, the Fed may hike interest rates over the next two years with banks and mortgage providers following suit.
To be sure, rising inflation is largely due to robust demand from consumers for all manner of goods and services. I wrote about this two weeks ago: this is not stagnation (i.e. inflation without economic growth), it is demand-based inflation compounded by supply chain issues and labor shortages, but it is inflation nonetheless.
As one final reminder, not all inflation is bad for all people and rising rates do not necessarily signal the inevitability of a future economic drop. There are certainly some beneficiaries of inflation, including Social Security recipients, who are going to get a bump in benefits of 5.9% next year, the biggest increase since 1982. Other negative effects of inflation may be mitigated by rising wages among workers (although more data is needed to support this hypothesis). Savers (especially those with a more conservative mindset who want the mostly-risk-free rates of return that comes from things like CD’s and money market accounts) are likely to welcome rising interest rates. For years now conservative savers have had relatively few options for safe returns as rates on bank deposits and bonds have just been so low; this could change in the years to come.
But higher interest rates do impact the cost of borrowing. When it is harder to borrow as much, economic activity typically subsides. When borrowers (including homeowners, businesses, credit card holders, and those with auto and personal loans) are paying more in interest, it means they have less to spend on other things, which has a dampening effect on the economy. That is something for people to monitor.
One thing to me is clear, however: rates are going up. If you or your business are looking to borrow, the time is probably now as it is not likely you will see rates as low as they currently are for quite some time to come (maybe ever).
Ben Sprague lives and works in Bangor, Maine as a V.P./Commercial Lending Officer for Damariscotta-based First National Bank. He previously worked as an investment advisor and graduated from Harvard University in 2006. Ben can be reached at ben.sprague@thefirst.com or bsprague1@gmail.com. Follow Ben on Twitter, Facebook, or Instagram and subscribe to this weekly newsletter by clicking below.
Weekly Round-Up
The bank where I work has numerous jobs posted, including several for a new branch we are opening in Brewer (shhh, this news is only semi-public for now, more of an announcement will be coming soon): https://recruiting.paylocity.com/Recruiting/Jobs/All/d6bb6ed3-1c29-452e-9e39-62011118d7f3/First-National-Bank
Here were a few other things that caught my eye around the web this week:
Wages are ticking up, too:
McDonald’s has hiked prices by 6%, but total sales are up by 10%. The CEO does not see much resistance or pushback from customers to the rising prices: https://www.bloomberg.com/news/articles/2021-10-27/mcdonald-s-coca-cola-jump-as-consumer-price-hikes-take-hold?sref=vuYGislZ
Via the Bangor Daily News, Acadia National Park has had a record number of visitors this year. Also tucked into the end of the article, the number of rescues by park rangers is also up 33%. https://bangordailynews.com/2021/10/26/news/hancock/acadia-will-set-a-new-annual-visitation-record-before-the-end-of-october-joam40zk0w/
From Tracy Brower in Forbes, “Empathy Is The Most Important Leadership Skill According to Research.” https://www.forbes.com/sites/tracybrower/2021/09/19/empathy-is-the-most-important-leadership-skill-according-to-research/?sh=fd0f57a3dc5b
Happy Halloween, everyone, especially this guy:
Got news tips or story ideas? Email me at bsprague1@gmail.com. Have a great week, everybody.
Mr. Sprague, thank you for this excellent piece. One nitpick if I may. In spotlighting the impact of an interest rate hike on purchasing power, I think you may have erred in your terminology. That is, you state that the difference of "three percent" means a difference in over $100,000 of property value. But don't you mean three percentage points, rather than three percent? In your example, the posited $1,499 payment would be a whopping 42.22 percent more than the $1,054, not three percent, barring any errors in my calculation.