Be Careful with Historically Low Interest Rate – They Can Be a Two-Edged Sword

When economic historians look back on our period, one of the most striking points that will distinguish the era may very well be the historically low mortgage rates. This past week, 30-year mortgage rates broke another record, this time dropping to 2.88%. Rates have been historically low for going-on 12 years.

Source: Econometric Studios

In many ways, the historically low mortgage rates are a boom to the housing and construction industries, among many other sectors. There is a dark side, though, to the “low rates are here to stay forever” story, in particular if one is a real estate investor.

 

The Two-Edged Sword of Historically Low Interest Rates
How could historically low interest rates be anything but bad? For investors (especially real estate), the answer is that it depends upon future demand for the asset they plan on selling when the time comes.

The Good
To be upfront, for most investors, low interest rates are usually quite good. For instance, when purchasing a home now at say $360,000 with 20% down and at a 30-year rate of 2.88%, the monthly payment is $1,195.

If the 30-year mortgage rate were to jump to 5%, then the monthly payment on that same $360,000 home jumps to $1,545 – an increase of 29%.

Source: Econometric Studios

Low mortgage rates increase demand – from both potential owners to potential investors.

The Bad
The risk to the picture is that low interest rates create demand – and a lot of it. The following is new home sales across the U.S. from 2010 through June 2020.

It is this increase in demand – and the subsequent price inflation – that should provide some pause to investors on what their exit plan is.

Source: Econometric Studios

If the exit plan is five years down the road when rates are higher and the home is in a place with unfavorable demographic trends, then the investment may turn out to be only moderately positive (it will probably still beat an investment in equity markets at this point). Remember, if one plans to sell the asset, then keep in mind that a buyer has to find the home a positive investment five years down the road – when interest rates are much higher.

Summing Up
Investing in real estate is a much safer bet right now compared to other asset classes – such as equities. With that said, be careful about your investment, especially on when you plan to sell the asset.