Interest Rates and the Economy

21 May

I have said previously that even though there are inflationary pressures out there, I did not feel that the lid on interest rates was going to be taken off during this election year.

Interest rates are very vital in the recovery of this economy. YES – housing needs to recover if the economy is going to rebound and; YES – a home is usually the largest purchase one makes, so affordability is directly tied to interest rates.

While interest rates reached an all time low of 3.84 percent, according to Freddie Mac, the number of individuals that can take advantage is mind boggling if they have good credit. Every 0.5 percent increase in the interest rate makes it impossible for a certain percentage of potential homeowners to participate in homeownership.

Motivation is a key factor here. If we create a 0.5 percent increase in mortgage rates for a 30 year mortgage for $425,000, say at 4.75 percent, the homeowner will end up paying $373,120.42 in total interest. Let’s say they delay and wait for a particular home to drop $15,000 and rates rise to 5.25 percent. For the same loan, they will pay $419,871.66 in interest over the life of the loan. That is a $46,751.24 increase in interest. From this example, you can see the $15,000 price drop vs. the cost of waiting has a big impact on the outcome.

When interest rates do move, there will be many renters who will “jump” off the fence. The challenge, then, is that it may have already cost them a half to 1 full percent in interest. Low interest rates alone cannot bring the buyer confidence we need. For many, it’s the stopping of the depreciation cycle which we feel will end in late 2012, that will make the difference.

Interest rates can speed up or slow down an economy. Right now with all that’s going on, they are neutral in the grand scheme of things; but they will again prove to be a major force in the years to come!

By Pat Riley (President and Chief Operating Officer)

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