How Increased Interest Rates Impact Your Property

Higher interest rates are coming, and you can thank inflation (and the Fed)

The rate of inflation in 2021 was 7.0%. To buck the current of inflation, the Federal Reserve steps in with plans to begin raising interest rates. Translated, it will cost more to borrow. The goals is to slow rising costs, hence, costs of properties and a reduction in the bidding wars we’re currently seeing in an economy where interest rates have been at record lows.

As interest rates rise, investors have less affordability; less buying power. Debt service is a part of an investor’s cash flow. Consider offsetting that by putting more cash into a deal.

When rates are high, investors have to watch how much their money costs them. It’s important to look at the numbers differently. Weigh the importance of increased risk when rates are higher versus when they are lower. Low rates encourage investors to borrow more.

Figure the mortgage costs into the numbers around the cash flow for your investment property. Will it still work with the new rates? And avoid adjustable rate mortgages (ARMs)! Commercial mortgages are typically five-year fixed loans, however, if you’re holding a property for more than five years, you have to consider whether or not you want the adjustable rate risk. You can lock in your fixed rate for longer terms many times but may have to pay points to do so. Watch out for the fees associated with these options. Keep in mind that the terms of your loan are a negotiation between you and the bank. Be prepared to ask for more or ask for their best before locking in with any one bank.

If you plan to hold a property between five and ten years, consider paying a premium for a longer-term fixed mortgage like a ten-year fixed loan.

Jen’s Investor Tip:

The housing market will stabilize

Rising interest rates have an effect on buyers and sellers as property values and housing prices correlate to mortgage rates. The health of the economy is also an important factor. If the economy supports rising costs because people are earning more, there’s a health and balance to the changes. So as long as the economy continues to grow and there is continued job and wage growth, interest rate increases have less of a negative impact and more of a stabilization of the housing market.

As rates rise, property prices often normalize to more realistic levels to meet the reluctance of buyers. The real estate market becomes more competitive and not just a seller’s market where bidding wars are the norm. People looking to buy a home—investment or primary residence—if they can afford the higher interest rate or put more cash into the deal, can benefit from the reduction in home prices and get better deals.

Tenants will become the balancing factor

When interest rates rise, the cost to borrow is harder for everyone. For renters who want to buy, being able to get into their first home becomes more challenging. Tenants will renew leases and put off their home buying until rates drop to more affordable levels.

Interestingly enough, the millennial generation continues to delay home ownership. They prefer to choose lifestyle, freedom and are risk averse. They happily stay in rental situations longer than others.

Investors typically raise rents to adjust for the rising cost of borrowing, passing increases to the tenant so cash flow continues to grow from the property. As tenant populations increase, available vacancies reduce which helps secure tenants into properties and allows for gradual rent increases and more cash flow for the investor. 🏠

Jennifer de Jesus