John M. Lee: When Interest Rates Rise

The inevitable is beginning to happen. With the economy doing better, consumer confidence rising and deflation non-existent, Federal Reserve Bank Chairman Alan Greenspan testified at Congress that he will start to increase interest rates soon. And just like that, the mortgage interest rates over the past month have increased one-half to one percent.

What does this mean for our real estate market?

The real estate market has been red hot since the start of the year due to low inventory, low interest rates and an abundance of buyers.

But with spring break, when decision makers are out of town, and the April 15 tax deadline, the market has slowed somewhat. These effects will be more evident in a few months, when we can see if this is a trend or a seasonal slow-down.

Real estate prices are definitely affected by interest rates. With a lower interest rate, buyers can afford to pay more for a home because a large portion of the purchase is usually financed. For example, on a $500,000 loan, the difference in monthly payments between a 5.5 percent mortgage and a 6.5 percent mortgage is $321, or about 11 percent.

However, to qualify for that loan buyers have to make approximately $1,000 more a month in income. If the increase in interest rate goes to 7.5 percent, it would be roughly double that amount. So you can see that an increase in the interest rate has a profound effect in the buyer's financial ability to purchase a home. When interest rates go up, real estate prices go down, unless other economic factors contribute to counteract the interest rate's effect.

We have had substantial double-digit appreciation in San Francisco over the past few years and no markets can sustain this type of growth without a break. Thus, with interest rates rising and poised to go up, probably after the presidential election later this year, the following are my recommendations.

On the positive side for sellers, it is better to put the property on the market sooner rather than later to take advantage of higher prices and still relatively-low interest rates. The listing inventory is still fairly low and multiple offers are still plentiful, but because we usually get our highest prices of the year in the early spring, the timing is right to get good sales prices.

For buyers, if you are planning to be in your home for more than five years, now is still a good time to buy real estate and lock in today's low interest rates.

Let's assume that the interest rates go up two percentage points. To keep the same mortgage payment at the lower rates, prices would have to drop about 22 percent to maintain an equivalent monthly mortgage payment. If you keep the home as a place to live for the next 5 - 10 years, normal appreciation in the marketplace will make today's prices look inexpensive.

For existing real estate owners not planning to sell in the near future, examine the financing structure on your properties. If your interest rates are higher than 6.5 percent, there are many attractive loan options in the current marketplace.

We have had a good run in the real estate market the past few years, despite the downturn in the economy and the dot-com bust. We will learn more in the upcoming months about the direction of the market and I will keep you abreast of new trends and developments.

John Lee is a top-selling broker at Pacific Union, specializing in the Richmond and Sunset districts. If you have any questions, call him at (415) 447-6231 or e-mail johnlee@isellsf.com.