The Fed just had another interest rate hike, we’re going to explain what this means for real estate agents. In this episode, we are joined by Max Leaman, CEO of LoanPeople and a good friend of mine.
What is Consumer Price Index?
In August, Inflation was up by 8.3%. When the number came out in September, it was 8.2%. CPI or your consumer price index is a measure of inflation.
Core CPI strips out food and energy because the government can’t control the cost of food or energy like they can’t control the weather. That rose more than was expected. But essentially, every month when a reading comes out, you’ll hear 0.6 or 0.7. When the numbers come out, you’re replacing the numbers from last year.
You have a 12-month period, and you add up those numbers for the 12 months. August, September, October, November, and so on and so forth. Last year, in July, August, and September, inflation was at its lowest points. You’re seeing .3 in July, .2 in August, and .3 in September.
When you’re looking at over a 12-month period, you’re adding all of those up. Now, when the numbers come out in June this year, it was significantly higher, and this bar is set quite low. So now you’ve replaced that number. August comes in, it’s even lower than last year. September was lower as well. So when you’re replacing those numbers, and you’re adding in a higher figure, it increases the overall inflation figure for the year over a year.
How Does Inflation Affect Mortgage Rates?
There are a lot of forecasters out there that have been talking about this all year. When you look at October 2021, we were up .6 right now, we don’t know what the number for October is going to be. The reading will come out in November. However, if it’s .7, or .8, or whatever it is, you’re only going up about .2 because you’re replacing this .6 figure. The bar is now set higher. You’ve removed these low-end numbers.
When the November reading comes out, we should see some measurable difference in inflation going down.
Mortgage rates follow inflation. They have for the history of time with the exception of Quantitative Easing. Quantitative Easing is when the government is coming in to buy mortgage-backed securities, buying treasuries.
The top line is inflation. Those are interest rates quantitative easing through to the beginning of January 2020. Throughout this year, kept rates artificially low, as the Fed stopped buying mortgage-backed securities that started saying they were gonna let things run off you can see that that’s when the rates started rising.
Why the Fed Stopped Buying Mortgage-Backed Securities
Essentially what they’re doing is they were keeping rates artificially low during the pandemic and everything else. They’re printing money left and right trying to keep the economy from coming to a complete halt.
They did a good job of doing what they wanted to do, but rates should have never been at 2.5% or 3%. That’s unrealistic, especially as inflation starts rising. So as inflation is going up, they’re keeping interest rates low. They kept saying, inflation is transitory, it’s temporary.
Now, what we’ve been seeing is some of these rates following inflations and rates also getting back to where they should have been if the Fed wasn’t buying up mortgage-backed securities. This is why we’re seeing mortgage rates spike and we are not well into the 7%.
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The Purpose of the Fed Raising Interest Rates
One of the reasons we brought this up is that some economists or experts are saying, you’ve done what you need to do, and it will take several months for the effects of that to happen.
Typically, when the Fed raises rates, it takes three to six months to see that impact. So when they started raising rates, we’ve just now really gotten to that six-month mark.
The other school of thought is that if you don’t keep going and keep raising rates, you might have a temporary pause, and then we’re going to be back to prices shooting up in every sector. It’s not just an inflation issue, it’s also it’s a supply issue too.
The reason that the Fed wants to raise the rate so quickly is that they need to get the money supply out of circulation.
They’re trying to make they’re trying to reduce buying power and bring down demand. So when demand comes down, prices start to come down. That’s how they’re trying to curb inflation.
What Would’ve Happened if the Fed Didn’t Raise Interest Rates
The Fed had to do something and the tool that they have is raising interest rates. They didn’t have a choice. The prices would have continued to go up and then would have had a hard fall.
So basically, the whole reason they’re doing this is to prevent a massive, huge recession, and then that school of thought is that they’re going to cause a little bit of pain instead of a lot of pain. What they should have been doing is dealing with all of this last year, but they didn’t.
Jerome Powell said that we clearly don’t know what we don’t know about inflation. These are the most powerful people in the world controlling the money supply. They don’t understand that this is a problem.
At some point, it’s now expected that they’re gonna raise the rate another three quarters in November, they’ll probably raise the raise under 50 basis points in December. Some people think that that’s possible, but there are some people including well-respected economists and forecasters saying, maybe it could push to March.
In the majority of Max’s career, the rates have been in the 4% range. 2018 was not a good year. Rates were coming up and there were two days when rates were over 5% and everyone was freaking out.
It came down to a little bit, then in 2019, you’re seeing them in the fours and high threes again which was carried through 2020 then COVID hit and we saw everything drop substantially. If you can have a rate of 4%, 5%, 6%, or even 7%, it’s still historically low.
Interest Rate Buydowns
There are some sellers offering interest-rate buydowns. You offer less on the home then you get your closing costs, and you buy down your rate.
Let’s say, if par rates 7 ½% par rate, meaning you’re not paying any points to get anything, you can pay one point, which is 1% of the loan amount which will typically buy the rate down a quarter to three eights of a point. Instead of being at 7 ½, you’re rated 7 ¼.
It was earlier a period of time this year, where one point would lower your rate, maybe half a point, or three-quarters of a point. One thing most of us agree on is that we are going to see a refinance boom in the next 12-24 months.
You don’t get to have years like 2021 without the pendulum going back the other way. If you were smart, you saved your money, you invested wisely, and you didn’t just go blow all your stuff thinking this wasn’t gonna end. But this is going to flush out a lot of people who either had just got in the business or didn’t live to realize that this wasn’t gonna last, it’s gonna flush a lot. This, frankly, is a good thing, because you don’t need to have it.
The worst Realtor in the world last year could sell 10 houses. Same with a loan officer. Now, you really need to be an advocate, you need to be an advisor, and you need to be an expert for your customer.
Buying Down Your Rate
So when you talk about buydowns, you can spend 1.1%. One point equals a 1% loan amount you can spend that you can get your rate down a quarter, maybe three-eighths of a point.
Two points might get it down another quarter or three-eighths. Now, the general rule of thumb is if you pay one point to lower your rate a quarter of a point it takes about six years to break even.
If you’re gonna not have this loan for that long, then you wasted that money. With rates being so high and so volatile, especially if you’re buying an investment property or second home, there is not what we call a par rate, there is no option to not pay any points. There is no liquidity in this market.
All the investors buying loans, buying mortgage-backed securities, understand that these are not 30-year loans, these are going to be paid off in the next 12 to 24 months.
They don’t want to pay a premium on them. A lot of this is going back to now you’re seeing borrowers especially investors pay a couple of points on stuff. They’re basically funding the liquidity themselves. Because investors, if I buy servicing from alone, it takes about five years to break even.
The 2-1 Rate Buydown
One of the tools that a lot of people are talking about right now is a 2-1 buydown. A 2-1 Buydown is if your start rate is 7%, then for the first year, your payments are based on a 5% interest rate. For the second year, your payments are based on a 6% interest rate.
So rough math, right on a 525,000 loan, you’re gonna save roughly $670 a month for the first year. And you’re gonna save about $335 a month for the second year.
Are Rate Buydowns for Everyone?
In order to make it work, you need the seller to pay that for you. Let’s say I’ve got this $525,000 loan and it’s going to cost about $13,000 to do the 2-1 buydown because the seller is subsidizing the difference in payment.
When you qualify for a payment, or when you qualify for the 2-1 buydown rather, you’re still qualifying at the 7½% rate.
Max worked with a customer and a property that was listed at 580 and they got it for 565 with $15,000, where the seller paid the closing costs. The buyers felt like the 2-1 Buydown was the best way for them to go.
They really wanted this house to be in the $4,100 range so for the first year, their payment is about 4,100, for the second year, it’s going to be 4,300, and for the third year is about 4,700.
The thought here if you refinance after two years or more. Whether it’s 12 months or 18 months, you’ve given yourself some way to at least get comfortable with where the payments go.
For real estate agents writing an offer on this, what you’re asking for is seller-paid closing costs. When you do a refinance, you’re rolling in the closing cost.
If you buy a house for $600,000, Max thinks that most people would believe that in December of 2023, that $600,000 house is going to be worth more than it is in 2022. So do you go up by 3%? Do go up by 2%? Who knows. But your closing costs are going to be roughly about 1½% when you factor in prepaid and escrows.
So as long as you appreciate more than one or one and a half percent, then you’ve covered that, versus waiting to go buy a house.
It’s absolutely silly for anyone to be waiting right now. If you look back at people who bought in 2007, everything goes south by 2008-2009. The homes of these people were worth less than what they paid for. However fast forward to 2012-2015, and they’ve appreciated a lot.
Nothing ever goes in a straight line. Even for people now that bought in May, their home today is probably not worth what they paid for if they were to resell it. However, if you fast forward three or four years, they’re going to be ahead most likely of where they are of where they were when they bought the property.
These are things to keep in mind. They also had to put in some $100,000 Extra to buy the house. Now, buyers are able to keep their money. They don’t have to go over the bid. They can take their time on a property. They can get the seller to pay things like closing costs.
But I guess if you can afford it, it’s going to look like a deal. You’re taking all that money that you were coming out of pocket and you’re paying a little bit more now. When rates come down, you refinance.
Connect with Max Leaman
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