How Do These Mortgage Rates Affect Current Homeowners?
At the time of writing this, we Americans are currently dealing with rising inflation as well as (the Federal Reserve aka the Central Bank) continuing to increase mortgage interest rates.
What does this mean for the real estate market? Who will buy houses now that rates are so high? Current homeowners are locked in at a low percentage rate. So even if a homeowner wanted to sell their house right now, why would they?
They would be giving up a home that they are paying less for because they are locked in at a low rate. Because they are locked in at a low rate their mortgage is guaranteed to remain low while home prices continue to rise.
Is this a good thing or is this a bad thing?
It depends.
On one hand, they could take that home, put it on the market, and then sell it for more than they paid. Which would be nice and they would make a profit.
But now where are they going to live?
Here is where the problem lies.
What is the homeowner supposed to do?
How will they find a new house while the real estate market is unpredictable?
Take out a new mortgage with higher interest rates?
Make higher mortgage payments every month?
No. That would be a financial mistake.
Instead, homeowners are much more likely to stick it out and just stay where they are while they wait for the market to settle.
Of course, the market won’t just completely stop. There are still going to be people who need to find homes for their growing family, because they need to relocate for work, or even retire.
However, most current homeowners will most likely hold off for a while.
How Do Mortgage Rates Help Curb Inflation?
First, let’s ask the question, what exactly is inflation, and what causes it?
Inflation is simply an increase in the cost of certain goods or products that are sold.
What Causes Inflation?
Well, many different things can cause the prices of certain products to go up. Here are the 5 most common causes of inflation:
- Prices of Materials Increase – One cause of inflation is the raise in cost of raw materials. Eg. A candle maker normally buys a bundle of beeswax for $10. One day they discover that the beeswax is now $15 for the same amount because the wax supplier lost several of their bee colonies.
Now the candle maker has to increase the price of their candles to make up for the additional cost of supplies. That is just the first example of inflation.
- Increase in Worker Wages – Another cause of inflation can be ethical wage programs which honestly is a good thing. A lot of companies are only able to provide their products at the prices they do because they use cheaper labor overseas. And as new laws or government programs are put into place, if the cost of labor goes up then the cost for the products does as well.
- Productivity Among People – Making people want to work can be a challenge. I’m sure you reading this right now at some point in your life said to yourself “I just don’t want to go to work today”. Everyone does.
And if there is a major decline in productivity, there is less product. Then the company won’t have enough products to meet their usual demand which can in turn cause the prices of that product to increase.
- Increased Tax – This reason is pretty self-explanatory. If the taxes on certain goods go up, so does the price.
- Too Much Money – You’re probably thinking “Too much money? There is no such thing!”. Unfortunately, it is true. You can have too much money.
Cash only holds its value because it represents something of value such as gold or oil. That is why it is so important for the government to know exactly how much money is currently in circulation.
If they just kept printing more and more money, eventually money would be just as common as any other type of paper and cause a decrease in its value. So if the value of the money has decreased the only way to continue using that money as a currency is by increasing the cost of goods.
How Do Interest Rate Hikes Help Slow Inflation?
Now that we have a better understanding of what causes inflation, the question remains… how do interest rate hikes help to slow inflation?
The central bank is the bank that helps service all of the banks and government here in the U.S. There are different central banks in different countries, but in the United States, the central bank is also known as the Federal Reserve or “the Fed”.
The Fed is who determines and sets the interest rate levels in the united states.
How do they do that?
Even though the central banks set the interest rates, they don’t have full control. The Fed does not have the ability to directly set interest rates. Instead, they indirectly set interest rates.
Are You Familiar With Open Market Operations (OMO)?
“Open market operations” is just their fancy way of saying they buy and sell securities (stocks, bonds, etc.) in the open market (any free and unrestricted marketplace).
The Federal Open Market Committee (FOMC) is the branch of the Fed that makes the decisions about short-term and variable interest rates.
This is how the Fed controls interest rates. It all has to do with regulating the supply of money. What money is coming in (deposits) and what money is going out (withdraws, loans, etc.)
The more the central bank buys these securities the more they are injecting into the economy. If they need to they will also sell these securities to reduce the supply of reserves.
This in turn will affect current short-term interest rates which will trickle down and affect long-term rates and so on and so forth.
It all has to do with the supply and demand for loans and credit. The more people who need loans the higher the interest rates will continue to rise. That will slow down the number of loans being given and help to slow the demand for loans being asked for by consumers.
