What Happens If Interest Rates Go To 10%?

Recently, Amy did a great job of highlighting how Americans are generally “feeling better” about the value of their homes.

For three quarters in a row, homeowners have effectively called a bottom, with the majority thinking their home’s value will not decline any further.  This quarter, the number of “optimists” was our largest yet:

• 34% think their home’s value will increase
• 47% think their home’s value will stay the same
• 19% of homeowners think their home’s value will decrease

Something to think about:

I have never had the chance to be a car salesman, but I have hired my fair share of them to be loan officers (no comments about used-car-salesmen-turned-mortgage-broker please… I know, I know) and over the years when I have bought a small handful of cars and have noticed one thing:

They almost always try to sell you a monthly payment rather than the total cost of the car.

Heck, I have even heard stories from ex-car salesman that many people will walk into the dealership and actually ask “what can I get for $xxx per month?”

I think when buying a house, the mindset of people might be a little different - but honestly, most people I work with generally seem to be more concerned about their monthly payment than the total amount of debt that they are taking on.

Since your total monthly mortgage payment is a function of 1.) loan amount, 2.) term of loan and 3.) interest rate - any change in any one of these variables can cause changes in your monthly payment. What I worry about is how dramatically your monthly payment can be affected when just one of the variables change.

Say for example that interest rates go to 10% — which is not out of the realm of possibility. What would that do to a monthly mortgage payment on a $300,000 home?

It would make the monthly principal/interest payment on a $300,000 loan go from $1,610 per month to $2632 per month - or an increase of 63% or $1,022 per month.

So if the theory of “people buy payment and not total debt” holds true - the obvious next question is “how much house can someone buy if interest rates are at 10% for about $1,610 per month?”

The answer?

About $185,000 vs $300,000 or so when interest rates are at 5%.

What happens if interest rates go to 10%?

I am no fortune teller, but I can’t see how it can be good for real estate prices.

Especially if what I learned from all of those ex-used-car-salesmen turns out to be true and people really do buy a monthly payment and not total price.

August 19, 2009