Are Low Mortgage Interest Rates Ever a Bad Thing in Real Estate?

December 19, 2023 by Tiffany Ferdus

Are Low Mortgage Interest Rates Ever a Bad Thing in Real EstateWhether you’re a first-time homebuyer looking for your first primary residence or you’re a seasoned real estate investor with a thriving portfolio of rental properties already, one of the first things you do when looking for a house is punch some numbers into a mortgage calculator to estimate your monthly expenses and determine how much you can afford to spend. In these calculators are many variables, including the purchase price of your house, details about property taxes, and more.

Perhaps the most influential variable to alter is your mortgage interest rate; it doesn’t take long to figure out that the lower the mortgage rate is, the more attractive the mortgage becomes, and perhaps for obvious reasons. But are low mortgage interest rates ever a bad thing in real estate?

The Role of Interest Rates in Real Estate

Low interest rates are generally good for anyone interested in buying real estate. When buying a property, most people borrow most of the funds necessary for purchasing a property. For example, you might put a 20 percent down payment down and borrow the remaining 80 percent of the purchase price. You’ll borrow this money from a financial institution, usually a bank, and that institution is going to charge you interest on the loan.

Over the course of the loan, you’ll pay a combination of principal and interest, gradually paying off the loan while compensating the bank for taking the risk of loaning you the money in the first place. Mortgage interest rates are usually represented as annual rates, so if you have a mortgage with 4 percent interest and you borrow $200,000, you can expect to pay $8,000 a year in interest (to start).

Where do banks get these interest rates from? First, understand that banks typically offer different interest rates to people with different credit scores; the better your financial standing, the better your interest rate will be. But besides that, the single most influential factor in determining mortgage interest rates is the target federal funds rate, which determines the interest rate associated with loans from the Federal Reserve to member banks in the United States.

Without getting into the details of how the Federal Reserve operates, it basically works like this. The Federal Reserve provides capital to member banks with interest, then those banks lend the money to consumers at a slightly higher interest rate to compensate for risk and turn a profit. Given this interaction, it’s easy to see how lower Federal Reserve interest rates lead to lower rates for consumers, and how higher interest rates lead to higher rates for consumers.

The Appeal of Low Interest Rates

There are many reasons why low interest rates are appealing to real estate investors.

  •       Lower monthly mortgage payments. Everyone wishes for a lower mortgage payment. It’s likely your biggest expense as a homeowner and one of your biggest liabilities as an investor. With a lower interest rate, you’ll likely have a lower monthly mortgage payment, giving you more financial flexibility and potentially greater profitability, all other factors being equal.
  •       A higher top end. Because of this dynamic, most people can afford to have a higher top end; in other words, they can offer more for a house that appeals to them. If you can only afford to pay $1,500 a month for a mortgage, a lower interest rate means you can push your best offer slightly higher and make yourself more competitive.
  •       Greater financial leverage. Real estate investors know that financial leverage is a huge advantage; if you can invest with borrowed money, you can see incredible returns without having to save up much capital yourself. Lower interest rates mean it’s easier to borrow money, and you can afford to borrow more of it, giving you access to greater financial leverage overall.
  •       Less “wasted” money. Interest you pay to the bank is functionally wasted. Paying off the principal of your loan means you’re building equity, but paying off the interest means you’re generating a profit for the bank.
  •       Lower risk (to an extent). Having a mortgage with a lower interest rate is, in a way, less risky. Even if you don’t make the best property decision, your overall expenses are going to be lower.

Are Low Rates Ever a Bad Thing?

Given those advantages, is it possible for low interest rates to ever be a bad thing?

Let’s take a look at some of the detrimental effects that low interest rates can have:

  •       Competition. First, low interest rates are extremely attractive, and therefore attract a lot of competition. If you attempted to buy a house in 2020 or 2021, when interest rates were at their historic lows, you likely experienced this for yourself; inventory was incredibly low, yet there was a cavalcade of interested buyers clamoring to make “as is” offers on whatever stock was available.
  •       Higher prices. Partially because of this, low interest rates lead to higher prices. There are more people buying homes, and because monthly mortgage payments are higher, they can afford to increase their offer prices. Downstream, this leads to an explosion in home prices.
  •       Inflation. Economic inflation is a complicated topic for real estate investors. But you should know that lower interest rates are typically associated with economic inflation, pushing the cost of everything higher for consumers. This can be advantageous; in an inflationary environment, the value of your debt goes down, so if you have lots of real estate debt, this can actually work in your favor. However, inflation can also be economically challenging and interfere with some of your other choices as a real estate investor.

While these disadvantages are important to consider, the advantages do seem to outweigh them.

What’s Next for Interest Rates?

As of the time of this article’s writing, the Federal Reserve plans to drop interest rates this year. This comes after an extended period of raising rates, which in turn followed an extended period of interest rates near zero. Expect to see lower mortgage interest rates soon.

The Bottom Line

The bottom line here is that there are some real disadvantages to low mortgage interest rates, including higher competition, higher prices, and inflation. However, there are so many advantages associated with low mortgage interest rates that it’s hard to say they’re ever a “bad” thing for homebuyers and investors.

As always, it’s important to work with experts as you make these complicated economic decisions. If you’re looking for a real estate agent who can help, you’re in the right place. Contact us today if you’re ready to begin or accelerate your search!

Tiffany Ferdus
Are-Low-Mortgage-Interest-Rates-Ever-a-Bad-Thing-in-Real-Estate

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