Whether you are a college student who is about to graduate and enter the real world, or an already established working adult, you need to be informed on both the facts and impacts of real estate and how it is affected by interest rates.
It has been well documented and agreed upon by many economists that over time the United States real estate market fluctuates tremendously and that the U.S. economy positively correlates with the real estate market. Since the introduction of the FHA and mortgage programs, researchers have discussed with great insight how the interests rates associated with the loans have had a great impact on real estate, and therefore, the economy.
It is essential to study the interest rates in order to aid one in making the right financial decision, be it to rent a property or to take out a loan to purchase a home. While some may argue that real estate is simply another part of our world, extensive research and education demonstrates that it holds a significant importance on our national and global economy, as well as on a personal level.
Where do these rates originate? There is one central bank that offers rates that the bank borrows from, London Inter Bank Offered Rate (LIBOR). In an article from Money.com, Josh Clark states that The United States treasury can partially control the rates by controlling the cash flow by using securities such as bonds. When money is available, interest rates drop, however, when there is not an abundance of cash flow, interest rates rise.
Currently, interest rates are at about 4.25%, a very low number to date and very attractive to buyers who are in need of a loan. Many researches are now stating that interest rates will go up in the years to come, which places soon-to-be college graduates in a difficult position. Ergo, we must make smart and strategic decisions based on facts and market trends.
DEMAND FOR RENTING HOMES AND APARTMENTS
During every dip in our economy we tend to see the demand for renting homes and apartments rise for various reasons. Qualifications for home loans by banks become tightened due to taking on the least amount of risks to ensure a safe return on a loan. Due to the difficulty of acquiring a loan, the rental demand rises during a slide in the economy because this is when the most amount of people are laid off from their jobs by companies needing to cut expenses to stay afloat — this forces people to take on a one-year rental/lease agreement rather than take on a 30-year loan that must be repaid.
OWNING A HOME
Individuals find it more attractive to rent because of the short-term lease agreements available, however, I personally am a huge advocate of owning your home no matter how difficult it may be. Throughout time home values have always risen and will continue to rise even after a crash, according to the Economist.com that has done extensive research and an array of tests to prove the theory. I also believe it is important to not only have liquid assets, but also property assets. Out of college if you have the ability to purchase a home, whether it be all cash or with a loan, I would advise doing so.
On the other hand, many of us graduating from college do not have that luxury. In this case I would recommend renting an apartment or home for a few years (1-6 years) while you accumulate wealth and save as much money as possible. Doing this will give you the ability to purchase a home either with all cash or with a smaller loan amount, thus making acquiring a loan easier because of the smaller amount of principal and lower payments.
INTERESTS RATES RISING? IT’S NOTHING TO WORRY ABOUT
Although interest rates are rising, there is nothing to worry about. While you may end up with a 5.5% interest rate instead of 4.24%, you are paying that amount of interest on a smaller principal. For example, if a person has a $100,000 interest only loan at 4% you will be paying $4,000/month. On the other hand, if you wait a few years and are able to pay half of that as a down payment then the loan principal is $50,000. If the principal is $50,000 with a 5.5% interest only loan the payment is only $2,500.
As you can see, although the rate seems higher the payment is actually much lower because of the principal amount you borrowed. This is very feasible for a working person to rent for a few years and accumulate as much wealth as possible before purchasing a home.
BUYING A HOME IS AN INVESTMENT
Being a homeowner not only has many benefits, but it is also one of the biggest investments one can make. As simple as it may sound, when one owns a home, it is theirs to keep, meaning they are no longer subject to increasing rents every year. The owner now has one of the most valuable investments in the world, a tangible asset.
Moreover, with a home, you have a tangible asset that can be used in many different ways. Firstly, homes typically increase in value.
Other advantages to owning your home is the equity involved that is correlated with the appreciation of a home. If you have a home that is worth $1,000,000 and have a $500,000 loan, then you have 50% equity. Conversely, if your home appreciates to $1,500,000 then your equity has now gone up from 50% to 75% without spending any more money.
Furthermore, you will now have borrowing power with the increased equity. The increased equity will then allow you to borrow or refinance your home in exchange for some equity in order to get another loan to borrow money for a business or investment.
Additionally, many people want stability in their lives and homeownership is one way to do so. Due to the fact that most home loans are fixed-rate loans, the payments on the loan will stay consistent during the life (terms) of the loan. Personally, I feel that owning a home is a necessity, if it is at all possible to do so.
DOUBTERS OF OWNING A HOME
While many experts such as Derek Thompson, a senior editor for The Atlantic, are against the notion of owning their home because of the recent crash and uncertainties, I could not disagree more. One saying by the distinguished Warren Buffet, “Be Fearful When Others Are Greedy and Greedy When Others Are Fearful.”
If this time plan goes accordingly, a person may likely own a home by their late 20’s or early 30’s. At this point, they are no longer saving a lump to own a home. I would still highly recommend saving somewhat as much as you were saving when you were trying to purchase a home, as this enables one to set up a future income by investing in other opportunities.
There are a number of different opportunities available such as investing those savings right back into real estate, whether it be an income producing home, apartment, or commercial property such as a retail property. By doing so, it will set you up in a great place for retirement, in a great position for when you have kids, and when you have to pay for them to go to college. Consequently, because you are still young you can use some of these savings in riskier investment because you have time to make it up in the future.
As people get older, it becomes much more difficult to take risks because of the potential downfall and hardships that may occur during the latter stages of one’s life. Real estate is one of the safest investments relative to its risk/reward correlation. The fact is that there is only so much land in the U.S and particularly the major cities, but there are more people being born everyday. This creates a high demand for real estate that will continue to grow.
Retirement is currently a delicate subject and is predicted to become even more of a sensitive subject in the upcoming years. According to the Financial Planning Association, one of the main issues with social security is that it will more than likely become irrelevant come the second half of the 2030’s. Many retired individuals today rely solely on social security as their source of income. If social security were to be cut off for them, they would be forced to go back to work.
Investing in real estate is a great way to not only protect oneself financially, but also have a surplus of money to spend on material items, vacations, and anything else one may want. Additionally, one of a parents biggest priorities is taking care of their family and with the extra income and real estate assets that come with investing that will all be taken care of, and more if the right decisions are made. The real estate market will always fluctuate, but if you plan, budget, save, and invest you will be set up for an easier life financially.
Junior Partner, The Moradifar Group