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After two years of high rates, the Federal Reserve cut its benchmark interest rate by a half-point in September, marking the first and biggest cut in four years. The Fed also indicated that it could make more cuts before the end of this year and into 2025.
So what do these changes mean for homebuyers? Not necessarily better deals or lower home prices in places like Silicon Valley, where there is much pent-up demand and extremely low inventory.
In a recent study by the National Association of Realtors, the San Francisco and San Jose-Sunnyvale metro areas (which include San Mateo and Santa Clara counties) were expected to benefit the least from lower mortgage rates among the nation’s 100 largest metro areas, with less than a 4% increase in affordability. Limited housing supply, higher down payments and less sensitivity to rate changes by high-income earners were among the reasons that might diminish the effects of lower mortgage rates in these metro areas, according to the study.
Here’s five things homebuyers should consider following the Fed’s recent rate cut:
Lower mortgage rates
For prospective homebuyers, lower interest rates can mean lower monthly payments or the ability to buy a more expensive home than they otherwise could.
This further decline in rates might be smaller than initially expected, however, as mortgage rates already factored in some of the expected rate cuts in advance of the Fed’s decision.
Homebuyers waiting for substantial interest rate reductions could be priced out once demand picks up and home prices continue to climb.
Easier qualifications for mortgages
When mortgage rates fall, the interest portion of monthly payments decreases, which lowers the total payment. This makes it easier for more borrowers to meet lenders’ debt-to-income (DTI) ratio requirements and qualify for mortgages that may have been unaffordable at higher rates. Lenders also consider borrowers less risky since the smaller monthly payments reduce the chances of default.
Lower rates not only help the process of qualifying for a new mortgage but also allow homeowners to refinance.
Stronger demand
Lower mortgage rates reduce the cost of borrowing, increase purchasing power and create a sense of a rush to secure a lower rate, all of which tend to drive up housing demand.
In areas where housing inventory is already low, this boost in demand can lead to more competition among buyers and ultimately put upward pressure on home prices as multiple buyers compete for a limited number of homes.
In Silicon Valley, which continues to experience a serious housing shortage, home price increases are expected to offset affordability gains from lower mortgage interest rates.
Housing affordability
Home prices and mortgage rates are the two main components that define a mortgage payment. The home price determines the principal amount borrowed, while the mortgage rate affects the interest paid on that principal. Thus, any changes in either of these factors substantially affect the overall monthly mortgage payment.
A recent analysis by the National Association of Realtors indicated that decreasing mortgage rates can more swiftly improve the affordability of homes compared to lowering house prices. A 1-percentage-point decrease in mortgage rates, for example, can reduce the monthly mortgage payment rates as much as a 10% reduction in home prices.
As noted above, in areas with a severe housing shortage, lower mortgage rates could be offset by higher home prices, as lower mortgage rates increase housing demand.
More inventory
At lower mortgage rates, buyers at all income levels can afford a greater number of listings, which can expand their choices. Expected rate reductions could encourage more homeowners to sell, which would increase housing inventory. Additionally, the Fed rate cut can have a positive effect on the construction industry. Lower borrowing costs would make it cheaper for developers to finance new projects, which could lead to increased construction of new homes.
Information for this column taken from Nadia Evangelou’s blog “The Upcoming Rate Cut: 5 Things Homebuyers Should Consider.” Evangelou is a senior economist & director of Real Estate Research at the National Association of Realtors.
Silicon Valley Association of Realtors (SILVAR) is a professional trade organization representing 5,000 Realtors and affiliate members engaged in the real estate business on the Peninsula and in the South Bay. SILVAR promotes the highest ethical standards of real estate practice, serves as an advocate for homeownership and homeowners, and represents the interests of property owners in Silicon Valley.
The term Realtor is a registered collective membership mark which identifies a real estate professional who is a member of the National Association of Realtors and who subscribes to its strict Code of Ethics.
