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The Interest Rate Fallacy

p>It's probably the

most mis-guided and over-used statement in real estate: “You should buy today because interest rates are going up.”  Time and again, I hear agents mindlessly and yet earnestly repeat that claim to me and to my clients.  Since it causes much pointless confusion, I recommend potential buyers to simply ask those agents to explain the rationale behind the statement.

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Yes, when market interest rates go up, mortgage interest rates often follow in kind and increase the size of mortgage payments.  So, in a virtual world where home prices never moved, then maybe the statement makes some sense.  But as we've all seen in the last decade, home prices do move and can often move quite dramatically.

Then, what happens to home prices in the real world when interest rates go up?  Unless buyers are suddenly willing and able to pay much more for the same house, prices will have to come down in order to compensate for the higher interest component of mortgage payments.  If you are planning to stay in the house for many years, that shouldn't be an issue.  But, it's still unpleasant.

So, will interest rates go up?  In the current environment, our central bank and Federal government want to keep stimulating the economy to ensure full employment.  One powerful way to do this is to through monetary accommodation or low interest rates.  Until our economy really goes full steam ahead, official interest rates will stay low, probably for another 12-18 months.  During that time, it's quite possible for interest rates to go lower.

Meanwhile, the other driver of interest rates is from investor expectations about inflation.  Currently, while food and gas are shooting through the roof, inflation has stayed muted as the high unemployment rates has reduced the buying power of consumers.  All the new government spending and new money being printed are barely able to counteract the great deleveraging of our last credit bubble.  The outlook on this front is even less clear, but once the market clears, asset prices and interest rates will adjust quickly upwards.

What should a prospective buyer or investor do?  My recommendation is to find an agent who can explain the key drivers behind a property's price and help guide the buyer towards properties with the best potential even if interest rates or inflation goes up.

Michael Cheng

Michael Cheng