Why does the fed raise interest rates? Well, we know it's to cool off inflation but this is complicated stuff when it gets down to it. Real estate agents need to have a basic understanding of how inflation works and why the Fed does what it does. A few weeks ago I was having happy hour with my good friend, Max Leaman and he went into detail about it.
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Consumer Price Index Definition
CPI or Consumer Price Index is a measure of inflation and deflation. Investopedia defines Consumer Price Index as the monthly change in prices paid by U.S. consumers. In August, inflation was up by 8.3%, when the number came out in September, it was 8.5%.
Every month, when a reading comes you’ll hear 0.6 or 0.7. When new numbers come out, you’ll be replacing last year’s. Last year, inflation was at its lowest point. You’re seeing 0.3 in July, 0.2 in August, and 0.3 in September. When the numbers came out in June 2022, it was significantly higher.
August comes in and it’s even lower than last year. September was lower as well so when you’re replacing the numbers and adding a higher figure, it increases the overall inflation figure for the year over year.
Inflation and Mortgage Rates
You’ll hear economists and forecasters talk about this all year. We were up 0.6 right now if you look at October 2021. When the November reading comes out, we should see some measurable difference in inflation going down.
Mortgage rates follow inflation. It has a history of time with the exception of Quantitative Easing. This is when the government is coming to buy mortgage-backed securities and treasuries. As the Fed stopped buying mortgage-backed securities and said they were gonna let things run off, you can see that’s when the rates started rising.
What the Fed was trying to do was to keep the rates artificially low during the pandemic. They were printing money left and right, trying to keep the economy coming to a complete halt. The Fed did a good job of what they wanted to do, but the rates should have never been at 2.5% or 3%. It’s unrealistic, especially as inflation starts to rise.
What we’ve been seeing is some of these interest rates following inflation rates are going back to where they should have been if the Fed wasn’t buying mortgage-backed securities.
Why is the Fed Raising Interest Rates?
According to Max, when the Fed raises interest rates, it takes three to six months to see that impact. We’ve just gotten to that six-month mark. It’s a supply issue too. If you don’t keep going and raising rates, you might have a temporary pause and we’re going to be back to prices shooting up in every sector.
Getting the money supply out of circulation is a reason why the Fed wants to raise the interest rates so quickly. They’re trying to reduce buying power and bring down demand. When demand comes down, prices start to come down, and that’s how they’re trying to curb inflation.
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What Happens the Fed Didn’t Raise the Rates?
If the Fed didn’t raise interest rates prices would continue to go up and then would have had a hard fall. The whole reason they’re doing this is to prevent a huge recession. Chair of the Federal Reserve Jerome Powell said that we clearly don’t know whether this process will lead to a recession. They don’t understand that this is a problem and these are the most powerful people in the world controlling the money supply.
The rates have been in the 4% range according to the majority of Max’s career. In 2018, Rates were coming up and there were two days when rates were over 5% and everyone was freaking out.
In 2019, you’re seeing them in high threes and fours which was carried through 2020, then COVID hit and we saw everything drop substantially. Having a rate of 4%-7% is still historically low.
What is an Interest Rate Buydown?
Some sellers are offering interest rate buydowns. You offer less on the home, you get your closing costs covered, and you buy down your rate.
An example of this would be, if par rates 7 ½% par rate, meaning you’re not paying any points to get anything, you can pay one point, which is 1% of the loan amount which will typically buy the rate down a quarter to three eights of a point. Instead of being at 7 ½, you’re rated 7 ¼. Earlier this year where one point would lower your rate or three points a quarter.
With rates being so high and volatile, especially when you’re buying an investment home or a second home, there is not what we call a par rate, there is no option to pay any points. Investors that are buying loans and mortgage-backed securities understand that these loans are going to be paid off in the next 12-24 months. They don’t want to pay a premium on them. If I buy servicing from them alone, it takes about five years to break even.
How Does the 2-1 Rate Buydown Work?
This is one of the tools that a lot of people are talking about right now. Let’s say your rate for the first year is 7%, your payments are based on a 5% interest rate. For the second year, your payments are on a 6% interest rate.
In order to make that work, you need the seller to pay for that for you. Say you have a $525,000 loan and it’s going to cost about $13,000 to do a buydown because the seller is subsidizing the difference in payment. When you qualify for a payment or a 2-1 buydown, you’re still qualifying at the 7.5% rate
Most of us do agree that we’re going to see a refinance boom in the next 12-24 months. If you were smart, you saved money and invested wisely, but this is going to flush out a lot of people who either had just gotten in the business or didn’t live to realize this wasn’t gonna last.
This includes Realtors. You don’t have to be in an oversaturated market with people who can just put their signs in the yard and loan officers saying here’s a rate and whatever. This is the time when true professionals come out and show their value. Last year, the worst Realtor in the world could sell 10 houses. Now, you need to be an advocate, adviser, and expert for your clients.
Related Blog: How to Calculate Your Mortgage Payment in Austin, TX
Should You Buy a Home Now or Wait?
It’s absolutely silly for anyone waiting right now. Looking back at 2007 and the people who bought homes during that year, everything goes south by 2008-2009. The homes were worth less than what they have paid for. Fast forward to 2011-2015, they’re appreciated a lot.
Even for the people who bought homes in May. Their home today is probably not worth what they paid for if they were to resell it, but in three to four years, they’re going to be ahead of where they are of where they were when they first bought the property.
Buying a home right now gives your the opportunity to get better prices and have options than what we were having to deal with earlier this year.
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