America's real estate market has been red-hot over the past few years, and most homeowners have felt secure knowing the value of their property was increasing. But now, some are worried rising interest rates will cause the price bubble to burst, and wonder whether it is time to sell.
The Early Show financial adviser Ray Martin offers tips on recognizing the best time to sell a home - and when to stay put.
Many homeowners are worried that creeping interest rates will bust the housing value "bubble."
Rising interest rates, Martin says, can make mortgages less affordable. Let's say you can afford $1,500 for a housing payment for rent or mortgage at 6.5 percent. Fifteen hundred dollars a month on a 30-year fixed-rate mortgage would buy you a mortgage of about $237,000. But, if mortgage rates go up 2 percentage points to 8.5 percentage points, $1,500 a month will buy you a mortgage of about $195,000, which is $42,000, or 17.8 percent, less.
In another example, if you have a $200,000, and a 30-year-fixed-rate mortgage at 6.5 percent, your monthly payment is $1,264 a month. If rates rise, say two percentage points, for the same $200,000 mortgage at 8.5 percent, the monthly payment is $1,538 a month -- 22 percent higher. So, if rates rise over the next 24 months by two percentage points, mortgage payments for new buyers will increase by almost 22 percent. And, Martin says, it's hard to make any case that wages will rise by this amount to offset this increase.
Therefore, rising mortgage interest rates will make housing, at current prices with higher mortgage interest rates, unaffordable for many people. In 1998, the interest rate was about 8.5 percent.
Today's housing prices are a function of demand and the ability to pay. If you negatively impact the ability of a lot of people to pay, then demand will decline and prices will have to stagnate or come down.
The housing market is not a stock market; it's thousands of different local markets. Local factors influence them more than interest rates. If a location is desirable to live in, the market will be hot if people really want to live there versus somewhere else. Martin says it's hard to believe there will be a real estate bubble bursting and bringing every home's value down, but there are areas where hot real estate market conditions exist.
Hot Real Estate Markets
Here are examples of several hot real estate markets and the average price increase for a median single family home in the past 3 years:
San Diego, Calif. 56.8 percent
Ft. Lauderdale, Fla. 52.4 percent
New York, N.Y. 43.6 percent
Baltimore, Md. 41.3 percent
Minneapolis/St. Paul, Minn. 32.9 percent
Source: Money magazine, June 2004
Martin says the low interest rates and a supply-demand imbalance have fueled the housing boom. There are several reasons for the imbalance: Builders, remembering the supply overhang of the '80s, are determined to avoid over-building and risk having too much supply sitting around. In some areas there is a short supply of building lots caused by zoning laws restricting urban sprawl, limiting lot sizes and the number of building permits issued each year. Growth in cities such as New York or San Francisco is limited because there's simply no room to build more homes.
There is also a supply squeeze because many homeowners are reluctant to sell. They've re-financed to a low interest rate mortgage and life is good. If they do entertain the idea of selling their existing home, once they get over the giddy feeling when they realize how much cash they could rake in if they sell, they sober up to the reality that they still have to live somewhere.
Who Should Sell Now?
Martin says there are stories of people who cashed in by selling their home and smiled all the way to Florida or some other desirable location. But usually, these sellers have owned their home for years and they are near retirement. If you are two or three years from retirement, Martin suggests selling your home -- especially if it's in a hot market. But, rising interest rates is not a reason to sell in the next two to three years.
Things to Consider Before Selling
If you sell your house, are you going to buy another house at a higher mortgage rate than you have now, or rent? Martin says you may not be living in the house of your dreams, but you may have the mortgage of your dreams. So, hold it and improve it with renovations.
If you are young and considering selling your condo or co-op, let's say for two or three times more than you paid, Martin doesn't recommend that you sell unless you are considering moving to a completely different location (out of the city you're in or to another country.) If that's the case, he said that selling is not a bad idea.
But if you are planning to sell and stay in the same city, think about what you will do with the money. Will you rent or buy another home? Martin says to keep in mind that investing in the stock market is risky. The value of stocks can go down to zero, but that's not true about land. Real estate values have gone up an average of approximately 6.5 percent a year for the last 20 to 30 years. The profits you make from selling a home may be life changing money for someone, but, Martin asks, what will you do after the excitement is over is something to think about.
Martin says to also consider the costs of selling such as
- Broker's Commission
- Capital Gains Tax
- State and City Transfer Taxes
- Association Transfer Taxes for Co-Ops and Condos
- Special Transfer Assessment.
Rising rates can help constrain the homes available, says Martin. This is one of the reasons why rising rates don't create a bubble.
So, look at the long-term trends in real estate. In the hot markets, rising interest rates may cause real estate values to go flat or down a little. Non-hot markets will probably stay flat and will continue rising again.
Martin says he saw the unwinding of the real estate bubble in 1987. He observed people in New Haven and Hartford, Conn., who bought condos for $150,000 and had to sell them for $90,000, five years later at a loss. Martin explains a housing bubble existed because there was more supply than demand and housing prices were not based on fundamentals. They were based on tax benefits, meaning you had lucrative tax loopholes that you could write off. When the tax law changed abruptly and took those tax benefits away, everyone tried to sell at once. It was a buyers' market. Once the price starts to go down, everyone waits to buy to see how far down it will go."
If you are buying in a hot market, Martin recommends that you do it very carefully and be ready to move -- make the deal quickly.
Here's some advice to anyone looking to buy a home in today's hot market.
- Be an Informed Consumer: In today's market, buyers need more information than ever before. Visit a real estate agent to find out the median and average selling price of homes in your area, how much they have appreciated in value over the past several years and how fast homes sell once they hit the market.
- Be Prepared for a Contest: This isn't your father's real estate market; competition for homes is like nothing you've seen before. For example, in early March a home in San Francisco that was reported to list for $559,000 almost immediately received 48 offers and sold for more than 25 percent over the asking price. Some experts are advising homebuyers to forego inspection contingency clauses in their offers in order to land a house, and even sending personal letters to the current owners, explaining why they deserve to buy the home. Clearly it's a risky move to suggest that buyers agree to buy a home without an inspection, but it's important to know what you're up against. By all accounts, if you're looking to buy a home in a competitive market, get yourself pre-approved for a mortgage and let the seller know you have a commitment letter in hand.
- Be Careful How You Borrow: Typically, up to about 35 percent of your net income should go toward housing costs. In response to the current housing market, banks have been offering a new range of mortgage products that allow people to buy more home than they can truly afford. Some loans allow borrowers to pay only interest in the early years of the loans, while piggyback loans combine a traditional first mortgage with an equity line of credit.
Perhaps the most significant trend in mortgages is the growing popularity of adjustable rate mortgages. Over 25 percent of all new mortgages last month were ARMs, according to the Mortgage Bankers of America. Even Fed Reserve Chairman Allan Greenspan said in a recent speech that more Americans should consider ARMs instead of the current gold standard of the 30-year fixed rate mortgage. Adjustable Rate Mortgages can be a smart choice if you know that you're going to sell the home in five to seven years.
Factors such as supply and demand, employment opportunities and education quality are some factors that can make a city desirable, which can offset rising interest rates.