Based on recent comments from Federal Reserve Chairman Jerome Powell, it appears that we’ll be in a low interest rate environment for at least the next few years. The current yield on the 10-year U.S. Treasury is less than 1 percent, pretty much the same as your bank deposit interest.
Of course, bank deposits are likely protected by FDIC insurance, so you have the comfort of knowing your money is safe and secure. But in the real world, are you making any money? The answer is probably not.
Your bank statement might not show a decreasing amount and your principal may be intact. But that’s often misleading. If you factor in rising prices throughout the economy, you’re probably losing buying power
Simply stated, as prices of goods and services escalate over time, your buying power decreases. Your money may be safe and earning a little bit of interest, but it just isn’t going to buy as much as it used to. Factor in that you may have to pay income tax on the interest, even though it may not be much, and your real rate of return could actually be negative.
In general, this low interest rate environment is not good for retirees and others who use interest to supplement their income. But there is a positive side of the story.
I believe that low interest rates, in conjunction with the cost of living increases are major reasons we’re seeing a red-hot residential real estate market. Data from the National Association of Realtors indicate that there are only 1.3 million homes for sale throughout the country.
That’s the lowest inventory of houses on the market since July 1982. And it’s 30 percent lower than the number homes that were on market at this time last year.
Even as home values and prices are increasing, the supply has been decreasing. Low mortgage rates and minimal interest on savings have motivated many buyers to jump in and buy now. Waiting longer would almost certainly mean a higher purchase price and a larger down payment.
For example, from August 2019 to August 2020, the median existing home price increased by more than 11 percent. So, in addition to locking in lower interest rates, many buyers saw the value of their home appreciate.
Borrowing $100,000 with a 30-year mortgage at 5 percent would result in a $537 monthly payment. At 3.5 percent, the payment would be $450, a savings of $87 per month. Looking at it from a different point of view, for nearly the same $537 payment and at the same low rate, you could get a $120,000 mortgage.
With so many people working from home and needing more space, and with historically low interest rates, it’s not surprising that, at least for the time being, the housing market is sizzling.
I always like to remind home buyers that it’s important to have a house payment you can afford, regardless of interest rates. A payment you can confidently make not only in good times, but in difficult economic periods as well.
If it takes two incomes to support the payment, I encourage caution.
While many have benefited from low rates, some have been hurt. That’s why it’s important to make smart financial decisions no matter which side of the fence you’re on.