Does it matter that interest rates are up a little?

We are now experiencing a rare time when low interest rates and reasonable home prices are happily coexisting

The housing industry continues to enjoy historically low interest rates, although they have risen off their lows of about 24 months ago.

The 30-year fixed interest rate is about 4.75 percent, up from the 3 percent range. When interest rates were at their absolute lowest, The Wall Street Journal declared it the best time to buy a house in the last 100 years.

So what does the rise in rates mean? In practical terms, not much at this point, because the effect of the rate difference between today and when the Journal made its declaration are negligible. The monthly payment differential on a $150,000 mortgage is about $100 per month. Housing prices are still a bargain and the combination of fair pricing and a low-rate environment means housing is one of the best investments to make.

The National Association of Realtors has what it calls the Housing Affordability Index, or HAI. In the Northeast, the HAI this time last year was 157.7; today it is 147.6. A value of 100 means that a family on a median income, has exactly enough income to qualify for a mortgage on a median-priced home. An index above 100 signifies that a family earning the median income has more than enough income to qualify for a mortgage loan on a median-priced home, assuming a 20 percent down payment.

For example, a composite HAI of 120 means a family earning the median family income has 120 percent of the income necessary to qualify for a conventional loan covering 80 percent of a median-priced existing single-family home. An increase in the HAI, then, shows that this family is more able to afford the median-priced home. As shown above, the recent rise in interest rates has had little effect on home affordability.

Mitigating factors

Going back 30 years, interest rates were 18 to 19 percent. I remember that period and still can’t believe it in relationship to today’s environment. Even given the harshness of those times, houses were still bought and sold and homeowners built equity. The current rise in interest rates to a large degree signals the continued recovery of the housing sector and economy in general.

In historical terms, high interest rates served to suppress home values because higher rates made mortgage payments higher, which meant that buyers were limited to the size of the mortgage they qualified for.

The inverse is that, with low interest rates, mortgage payments are lower, which means buyers can qualify for higher mortgage amounts. This allows buyers to purchase more home for their money and brings more buyers into the market. This cycle in turn constricts the inventory supply, which forces home prices to rise.

The other mitigating factor that offsets a rise in interest rates is the federal income tax deduction for mortgage interest and real estate taxes. Let’s say that your combined interest and real estate tax payments equal $12,500 annually and your federal tax rate is 28 percent. Multiply your total deduction by your tax rate of 28 percent: 12,500 x 0.28 = $3,500. You have just lowered your federal income tax by $3,500. We all know about these deductions, but it has more meaning when you do the math.

Year over year, New Hampshire sales volume is up about 8 percent and closed transactions are up 13 percent – respectable increases. Inventory in some markets is in short supply, other markets not so much. In general, the ratio of homes available for purchase and the number of buyers in the market is in balance.

What factors could upend the housing recovery?

• Mortgage underwriting standards are loosened too quickly. Cheap credit is beneficial. Cheap, easy credit will overheat the market and return housing to the wild up-and-down cycles that we are now working out of.
   
• A flood of inventory hitting the market in quantities that outpaces the economy’s ability to create new buyers through job growth and/or new family formations. Job growth is critical to housing because that’s what produces the revenue for home purchases.
   
• A large increase in interest rates without a corresponding increase in disposable household income.

We are now experiencing a rare time when low interest rates and reasonable home prices are happily coexisting. How long these dynamics will last is anyone’s guess. The age-old game of trying to time the bottom of the market is pretty easy to do right now. So whether you are a first-time buyer, moving up or downsizing – don’t wait too long.

Christopher J. Masiello is CEO and president of Keene-based Better Homes and Gardens Real Estate The Masiello Group.