By Bruce Cathcart
About 38 years ago while a student at UCI and struggling to stay awake in my Econ 101 class I
vaguely remember my professor stating, “In a free market the amount of interest paid was the
reward relative to the amount of the risk taken”. In plain English then, the higher the risk, the
higher the interest rate. If that were true today, with over 5 million foreclosures, half again
as many short sales and over 1.5 million loan modifications you would think making home
mortgage loans was a pretty risky business and that interest rates would be sky high. But that is
not the case. In fact today’s home loan mortgage rates are at or near historic lows. Rather than
try and explain why this is I am just going to describe some of the different types of mortgage
loans that are currently available in today’s market and the relationship that the interest rate
has to the real estate market prices.
First we need some new vocabulary. Interest rates can be fixed, variable (adjustable), or a
combination of the two. A fixed rate of interest stays the same for the entire length of the
loan. A variable rate, usually called an Adjustable Rate Mortgage (ARM) can change at different
(set) intervals based upon an economic index. A combination rate can be fixed to start usually
5 to 7 years and then it becomes a variable rate. Most commonly home mortgage payments
are spread out (amortized) over 15 or 30 years although recently 10 and 40 year loans have
become available. Government loans generally refer to the FHA/VA loans. These are loans with
low down payment requirements that are insured by the government. Conforming loans are
loans that meet special Freddie Mac and Fannie Mae guidelines. Government and conforming
loans are limited in their loan amounts based upon the local area median home sale prices.
(In Riverside County the current conforming loan limit is $417,000.00 and the FHA loan limit
is $500,000.00). Jumbo loans are the loans used when the amount of the loan exceeds these
limits. Each monthly payment is made up of “principle” repayment (the amount by which the
loan amount is reduced) and interest (the bank’s reward for loaning the principle).
Generally speaking, lower interest rates result in higher sale prices. Why? Because a lower
interest rate gives a buyer more purchasing power. For example if a buyer can afford $1,000.00
per month for principle and interest payments on their home mortgage, at 3.5% interest (fixed
rate, amortized over 30 years) they can borrow $223,000.00. At 6.5% interest (which was the
interest rate just a few short years ago) they can only borrow $158,000.00. The only thing that
has changed is the interest rate and look at what a huge difference it makes in how much a
buyer can borrow for the same monthly payment. This is exactly what is happening in the
Coachella Valley Real Estate market and across America today as the current low interest rates
are increasing buyers ability to pay more and pushing real estate prices higher. Perhaps this is
part of a grand plan to resolve our national housing crisis and get our economy back on track?
So much for the free market theory… but it seems to be working, at least for right now. Of
course the reverse is also true (that higher interest rates will result in lower sale prices) and
so it is very important to keep an eye on the interest rates. For that reason this week we are
introducing a new graphic that will allow CV Weekly readers to quickly and easily check out the
current interest rates each week.
This week’s real estate tip: If you have not already done so, take advantage of the incredibly
low interest rates available today and reduce your monthly mortgage payments by refinancing
your current home loan or figure out a way to buy a house either to live in or to use as a rental
investment!
Bruce Cathcart is the Broker/Co-Owner of La Quinta Palms Realty, “The Friendly
Professionals” and can be reached by email at laquintapalms@dc.rr.com or visit his website at
www.laquintapalmsrealty.com.
