In recent months, there has been a lot of conversation surrounding rising interest rates. When will rates increase? How high will they go? How will it affect me?
Suffice it to say, most people get nervous when it comes to issues of money, and rightfully so…especially when the tide is not working in their favor. Every quarter of a percent rate increase not only raises your monthly mortgage, it also adds thousands to your total cost of a home in the long run. But before we panic too much, let’s dive deeper into the details of home loan interest rates.
How does the Federal Reserve affect interest rates?
The Fed was established over a century ago with the purpose of better regulating monetary systems in the U.S. When private banking institutions must borrow money themselves, they (like their clients) must pay interest on the amounts borrowed. Therefore, if the Fed increases its rates, private banks are put in a position where they too must increase rates. On the other hand, if the Federal Reserve decreases its rates, private institutions have more flexibility to lower theirs as well and (in so doing) remain competitive in the market.
Why does the Federal Reserve adjust interest rates?
As previously mentioned, the Fed is largely tasked with helping maintain a healthy economy. A variety of factors are at play in doing this, but interest rates are perhaps the most effective tool in the box. Regarding simple supply and demand, for instance, if the economy needs to be “sped” up, interest rates may be lowered in hopes of encouraging consumer purchases. On the other hand, if the economy is being overwhelmed with demand but there is too little supply (creating other economic problems), rates may be increased to discourage (even restrict) consumer spending.
What is Prime Rate?
The majority of banks look to the Wall Street Journal for the “baseline” interest rate in the country on any given day. Though it may not mirror the Fed’s current rate exactly, it is the best indicator of what is happening in the country and closely follows it.
If all banks are dependent on the prime rate, why do rates differ from one bank to another?
Banks are businesses like any other and, as such, have varying degrees of investments, liabilities, and expenses. As rates change, some lenders may find they are losing money on loans previously expected to be profitable. On the contrary, if a particular bank is in a relatively good financial position with current loans, it may be able to remain more competitive (even in spite of interest rate increases).
What does all of this mean for me?
First of all, we must take two things into consideration. Number one…for some time now, interest rates have been historically low. And not just low, but crazy low…like 2-3% low! As with so much of the chaos we have experienced since COVID-19 hit the scene, low interest rates have kind of started to become the norm. Even so, the average person has known all along that things cannot continue at that rate (pardon the pun). It’s easy to be panicky about the sight of rates rising, but let’s hit reset and remember that pre-COVID “normal” was never as low as it has been. Perhaps more importantly, we are still nowhere near the historically high rates we have seen in the past (high teens and even twenties in the 1980’s). Obviously, the anxiety is in not knowing when the increases will stop; but for now, it’s worth noting we are still within the limits of pre-COVID “normal”.
Secondly, interest rates (like so many other things in life) are not permanent. They rise and fall year by year and, though it may cost a little more on the front end to proceed with your plans for building a new home, there is always the option to refinance later on down the road. Generally, even a one-point decrease warrants considering the penalty of closing costs in exchange for long-term savings. While we are currently seeing increases, a decrease will naturally come back around as well.
So, should I proceed with building a home or not?
For many of our prospective clients today, this is the golden question. As professional homebuilders (and fans of Ramsey Solutions), our recommendation is this. First, do not enter into an agreement or process that you do not fully understand. Gustafson Properties, LLC, as with many other building companies, has an escalation clause in place to protect itself from large, unexpected increases in costs. We are open with prospective clients about the conditions of the market and the risks we see on the horizon. Understanding this, hopefully, helps clients to develop an idea of whether or not they should proceed. We are all humans with limits to what we can predict, but transparency goes a long way. If you are uncertain about the amount of disclosure you are receiving from a building company, it is best to pause and make sure nothing is being miscommunicated.
Next, make sure you have your personal finances in order before proceeding with a new home build. This is nothing new. Even in the best of times nationally, it is ill-advised to make a major financial move when you are already covered in debt. Ideally, when construction is complete and you are finalizing your permanent mortgage, it should not exceed 25% of your net income.
Finally, have a good savings in place (equivalent preferably to 3-6 months of household income). Building a new home is already a big financial decision, and new home clients are already naturally crunching numbers during the process. Having a solid savings helps ensure you’re protected from the unexpected events in life…a blown car engine, a bad A/C unit, or just an unexpected plumbing leak. Any additional savings can also be applied to upgrades or overages that could arise during the construction process.
So, what does all of this mean for the average consumer looking to build a new home? It means the same as it always has. Don’t move forward with building a new home until your personal finances are in order. Be prepared for some unexpected events with a strong savings account. Discuss alternative solutions (such as refinancing at a later date) if rates exceed what you would have hoped for. Take the steps to protect yourself, regardless of what is happening all around you. Then, you can enjoy the building process instead of worrying about market conditions.
And if you are still looking for a custom home builder, we would love to speak with you! Schedule a phone call online at www.gustafsonproperties.com/contact-us/. We look forward to hearing from you soon!
