What Investors Need To Know As Interest Rates Rise

Key Takeaways

  • Current mortgage rates are around 7.05%, close to the highest since 2008.
  • Rates are expected to climb as the Federal Reserve increases the federal funds rate.
  • Each housing segment faces different challenges resulting from higher interest rates and slowing home sales.

Home prices were on a roll, increasing steadily for some time. But, with the Federal Reserve raising interest rates to fight inflation, house prices are beginning to stall. Not only that, but home builders are stopping production.

Here is where mortgage rates stand and here’s the impact higher interest rates have on the housing industry as a whole.

Current mortgage rates

As of October 14, 2022, the mortgage rate for a 30-year fixed mortgage was 7.05%, a slight drop from a high of 7.10% the previous week. The 15-year fixed is 6.24%, and the 5/1 ARM is 5.34%.

November 2008 was the last time the fixed rate was over 6%. The Federal Reserve raised the federal funds rate several times during 2022 to slow inflation. These increases caused banks to raise the interest they charge on mortgages.

Mortgage rates vary from bank to bank, but you can expect to pay around 7% interest on a 30-year fixed mortgage for the foreseeable future.

Where interest rates are headed

Mortgage interest rates are expected to stay high through October 2022 and are likely to go even higher. The next Federal Reserve meeting is in November 2022, but it’s unclear if the board will raise rates when it meets.

Current forecasts anticipate an increase in the federal funds rate, currently set between 3% to 3.25%. It could hit 4.4% by the end of 2022 and increase further in 2023, possibly reaching 4.6%.

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The impact of higher rates on house prices

For many years, the Federal Reserve kept interest rates historically low. As a result, you could borrow money at a very low rate. This cheap money helped fuel the housing market.

Also adding fuel to the fire was the pandemic, which saw people fleeing large metropolitan areas both out of fear and since they could now work from home.

With lockdowns came supply chain issues, making it extremely difficult for home builders to build new homes. Housing prices soared when you combine a low housing inventory with high consumer demand and cheap money to borrow.

In many parts of the country, people were bidding over the asking price and waiving inspections to reach an agreement of sale. Now that the Fed is aggressively raising interest rates, purchasing homes has slowed dramatically.

Higher interest rates play a major role. Last year, a 30-year fixed loan stood at 3.5%. On the median home price of $440,300 with 20% down, your monthly principal and interest payment would be approximately $1,582.

Using the same numbers but with the current 7.05% interest rate, the monthly payment is around $2,355. This is more than a $770 difference each month.

Home sellers are beginning to lower their asking price as homes sit on the market longer. It’s reasonable to expect the slowdown to continue as rates rise.

How higher interest rates influence bank stocks

Higher interest rates benefit the banking sector because lending institutions can charge more interest on the money it lends. However, some lending products, such as fixed-rate mortgages, are likely to reduce demand because fewer people can afford the monthly payment.

Instead, homebuyers might opt for shorter-term adjustable-rate mortgages for lower payments and hope that interest rates will be lower in a few years than they are today.

Lenders still profit from certain forms of consumer lending, but those profits come more slowly now compared to when the interest rates are down. However, this doesn’t mean that all forms of lending run dry.

Businesses and individuals still need to borrow money to fund their projects and pay for necessities. Some may borrow less than before due to the higher interest, but they still borrow. Banks continue to profit, and their stock prices benefit as a result.

This is not to say bank stocks will be immune to market pullbacks or even a recession. Nevertheless, they should weather the storm better because they are earning more income from loans with higher rates.

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Higher interest rates and home builders

In contrast to banks, home builders suffer during times of high interest rates unless they also offer mortgage financing or partner with a lender.

Homebuilders borrow money to purchase the tracts of land they need to build, buy building materials, and pay for labor. They get lower interest rates on their loans as they pay them back in full, more quickly. This improves their profitability since the cost of borrowing is minimal.

Higher interest rates for construction loans impact a home builder’s profitability and sales. Pre-construction orders and sales drop, finished unit sales slow down, and the monthly payment for a finished home increases.

Ultimately, this pushes the price out of reach for buyers who could afford the payment before the interest rate hike. Fewer home sales make it more difficult for the home builder to pay off their loan, causing the builder to pull money from other areas of the operation.

A home builder with losses and reduced operating income is likely to see a reduction in its stock value due to the downturn in consumers’ buying power. Projects are often abandoned, and the home builder has to restructure to survive until interest rates go down again.

This is being seen throughout the industry today. Some home builders are selling off their inventory of built homes to investment groups, not buyers, so they can get the inventory off the books and earn income.

The next few months for homebuilders look challenging as the Fed plans to keep raising interest rates. This will further slow the housing market.

In the long run, however, this could greatly benefit home builders. With low inventories, they can build new homes and charge a premium.

Interest rates and retail building materials stocks

Retail home materials stocks, like Home Depot and Lowe’s, are in the middle ground regarding their outlook. On the one hand, they can expect an increase in sales since people will choose to update and remodel their current home instead of buying a new one.

On the other hand, inflation is still high, making it hard for people to afford everyday expenses. This could put home remodeling projects on the back burner.

For investors, it will be important to watch these retailers’ inventory levels and earnings reporting. These will give insight into whether people choose to update their homes or if inflation is too high.

Bottom Line

The housing industry makes up a large part of the U.S. economy. With interest rates rising, you can expect home prices to cool off and drop. The impact this will have on industries connected to the housing market varies.

Some sectors, like bank stocks, should handle the change in the housing market well. But home builders could be in for a tough winter and spring. As an investor, your best option is to diversify in order to limit risk.

Q.ai’s Investment Kits can help you diversify across a range of industries. Our artificial intelligence scours the markets for the best investments for all manner of risk tolerances and economic situations.

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Source: https://www.forbes.com/sites/qai/2022/10/18/housing-market-crash-2022-what-investors-need-to-know-as-interest-rates-rise/