According to Bankrate.com, the latest rate for 30-year fixed mortgages is 4.04%. So where are they headed, and how will this impact real estate prices?

My opinion is that rates are going to gradually inch higher, and the impact on prices will be negligible. Here’s why…

Freddie Mac provides a table of monthly mortgage rates (30-year fixed) going back to 1971. Over this 30+ year period we saw a high of 18.45% in October of 1981. The low was 3.35% observed in November and December of last year. I would guess that will stand as the low point as the economy shows gradual improvement, and the Fed signals an end to stimulus as the economy improves. Certainly the longer your time horizon as a home buyer or real estate investor, the more likely you will see higher mortgage rates 3 years from now, 5 years from now, etc.

The conventional wisdom might be that higher mortgage rates should put downward pressure on prices. Here is a simple table showing loan amounts from $700,000 to $750,000 (typical for a New York apartment purchase), and mortgage rates from 3.5% to 5%. As rates rise, purchasing power declines.

Loan Amount
Rate $700,000 $725,000 $750,000
3.50% ($3,143) ($3,256) ($3,368)
3.75% ($3,242) ($3,358) ($3,473)
4.00% ($3,342) ($3,461) ($3,581)
4.25% ($3,444) ($3,567) ($3,690)
4.50% ($3,547) ($3,673) ($3,800)
4.75% ($3,652) ($3,782) ($3,912)
5.00% ($3,758) ($3,892) ($4,026)

Despite the 70bp increase in mortgage rates over the last 6 months I do not envision a noticeable drop in prices however. At 4% we are still very much at the low end of the historical range. The mean average since 1971 is 8.62%. The mean average over the last 20 years (excluding the hyperinflationary early 80s) is 6.37%. Buyers, particularly in the New York market, explicitly or intuitively understand this. So as they see mortgage rates beginning to rise they will likely move to close on a purchase and lock in a low rate.

Second, inventory still appears to be historically low. Our May snapshot for Manhattan still shows inventory down 23% YoY. The inventory numbers may be different elsewhere in the city but the overall message seems to be that sellers are not compelled to sell at the moment. So even if rising rates put some downward pressure on prices, that in turn could continue to keep inventory low and prices afloat.

Certainly if rates jump dramatically, an interest rate shock could disrupt the status quo and push prices lower. There are far smarter people than I debating the likelihood of such a shock. What we do know is that the Federal Reserve will do everything in its power to keep rates low and maintain an orderly economic recovery. They are not presently concerned about inflation.

Also an important factor in this market are rents. Rents have been on the rise recently, as vacancy rates remain effectively at 0% in and around Manhattan. Vacancy rates around 2% or so are considered to reflect normal turnover and repairs (mostly repainting required by law), and so are effectively 0%. High and rising rents motivate renters to buy.

So in sum, gradual increases in mortgage rates appear likely to be offset by important market factors supporting real estate prices.