Let’s get this out of the way– assuming it isn’t a global economic calamity that will cause this, of course we want interest rates to drop dramatically. The amount of money that goes poof every month being smaller is better for buyers, sellers, and just about everyone else. Even for lenders. Buyers paying lower interest rates means sellers have more buyers in the pool and therefore can get higher prices, all without raising the mortgage payment. Win/win. There’s your perfect world scenario.
We don’t live in a perfect world. Here’s some history: in November 2018, the average rate for a 30-year conventional loan was just under 5%, which was the highest it had been in seven years. The average rate bottomed out to 2.65% in January 2021. You may remember 2021 as, among many, many other things, being a chaotic time in the housing market. There was fierce competition, and prices were soaring. In fact, average home prices nationally rose 30% from Q4 2018 to Q4 2021 (and they weren’t even done rising yet– the peak would occur a year later).
Fast forward to now: interest rates start with a 7 in front, and prices in our area at least are not too far off from where they were at the 2022 peak. However, inventory is higher (since houses take longer to sell), houses are selling for closer to their asking prices, and it’s less likely that a buyer will be in a highly competitive multiple offer situation.
It is my personal, semi-educated belief that if interest rates drop below 6% we will see a lot of buyers and sellers come back to the market. That’s the magic number. While inventory has been rising, active listings are still lower than they were three years ago. That’s because sellers have been reluctant to part ways with their low mortgage rates, but as the gap narrows between what they’re paying now and what the replacement loan would cost– and more owners gain enough equity to make that next purchase in cash or with a small loan– more sellers will sell. More buyers will want to buy, as their affordability picture gets better. At the numbers we’re seeing now, every 1% that interest rates drop means about a 7% drop in monthly payments, which is $300 per month on a median-priced home in our area. That’s a cool $100k over the life of a 30-year loan.
So why buy now, instead of wait for this theoretical drop in rates? First off, “theoretical” is a good word here, because nobody actually knows if rates will go up, go down, or stay where they are. Let’s assume though for the sake of argument that they do drop 1.5% in the relatively near term, and bring things under that magic number of 6%. It is entirely plausible that this creates a surge in activity that looks like a junior version of 2020-2022, with buyers– scars of 7-8% interest rates imprinted upon them– scrambling over each other to get what they can. From 2020 through 2023, the median price of a home in our area rose 25%. If interest rates drop 1.5%– meaning the cost of a mortgage payment is 10-15% lower– that reduction could easily be negated by a rise in home prices.
A while ago I wrote about how the saying “you can always refi” makes me cringe. It still does. To refinance a loan means that several conditions must have been met: interest rates have dropped enough to cover the closing costs, you have equity in the house (so values have not dropped), and you can still qualify for the loan. Since we’re assuming things though, let’s go ahead and assume all those conditions exist. You bought a median-priced home at 7.25%, interest rates are now 5.75%, houses are rising in value, and you’ve still got a job. You can now erase $500 or so a month from your mortgage payment. Meanwhile, home prices have risen 7-10% since you bought your house, so even though someone buying now will get that 5.75% rate without a refi, they’re paying more for the house and facing more competition for it, wiping out any advantage they have from lower rates. They also have less room to reduce their rate in a refi than you did. Sure, if rates drop further they can also refi, but so can you.
To recap, let’s roll through the scenarios:
- You buy a house now, and interest rates drop. Chances are, home prices will continue to rise, but you came in at a lower price and you can refinance. You now have the same rate as someone buying in the future but for a lower-priced house.
- You buy a house now, interest rates rise, and home prices stay flat. As it turns out, you got in when rates were comparatively lower, and you’re paying less than someone buying in the future.
- You buy a house now, and regardless of what interest rates do the economy collapses in on itself and home prices drop 30%, and because you somehow managed to keep your job through this collapse you are beating yourself up for not waiting to buy. That was 2008, and I’ll save for another post why it won’t be going down like that again.
The bottom line is, when thinking about interest rate drops, be careful what you wish for. There are a lot of people waiting for that exact thing to happen. It’s a lovely fantasy to believe that rates will drop but prices won’t rise, but that’s all it is: a fantasy. If you want it and can afford it now, don’t spin your wheels trying to time the market.
