Interest rates might not sound like the most exciting topic, but they’re absolutely crucial for your real estate investment success. There’s all types of rates out there. The federal funds rate the prime rate. we’re gonna break them down today, the ones that you need to know how they affect your mortgage, and ultimately how interest rates affect the real estate market and your housing prices.

Stay tuned. I’m really excited for this one. This is some of the best news that we’ve heard in a long, long time.

Well, welcome back to the Short-Term Rental Riches podcast. I’m happy you’re here again, and I’m especially excited for this episode today because something fabulous is happening that hasn’t happened in years and years. In fact, if you go all the way back to 2021, you’ll find an episode that I did talking about why you needed to refinance back then because interest rates.

We’re headed up and now good news to all you real estate investors out there. Those rates are starting to come back down, but there’s a lot of different rates out there. We have the federal funds rate, we have the prime rate. We have this thing called L-I-B-O-R, or SOFR. What the heck are all these rates?

I’m gonna explain that today. Make it really easy for you.

So the amount that we pay for mortgages really starts with the federal funds rate, but it’s a little confusing because it’s not the federal government that’s actually setting mortgage rate.

The federal funds rate is what banks charge other banks, but it’s not what you pay as a retail investor.

Before we get into the simple explanation on how these rates actually affect your mortgage rates, 

There’s a few key factors that affect whether or not the Federal Reserve will increase rates or lower rates.

A really big one has to do with inflation.

If inflation’s out of control and prices are going through the roof, well then the Federal Reserve needs to constrict the money supply so that there’s less money out there to push those prices higher.

Luckily, we’re in an environment now where inflation is now under control.

This is of course, based off the US government’s numbers or what you see in the media, which we gotta take all that with a grain of salt, right? Another reason why interest rates might change has to do with the economic outlook. Is GDP going up or down? And how are jobs doing well right now? Jobs are not doing that great.

Of course, you can attribute AI and automation to a lot of this, but we’re losing thousands and thousands of jobs, so with inflation under control and us losing a lot of jobs, this gives the Federal Reserve the right you could say, to go ahead and lower interest rates back down, meaning that things will get more affordable because it’s cheaper to borrow money.

So those are the main principles, but of course there’s some other ones that could go into this, like energy spikes or if we go into war, those things all affect the future Economic outlook and interest rates are designed to control our economy.

So if the fed rate doesn’t actually control what we pay as a real estate investor with our mortgage rates. Then how is that controlled? How is that calculated? Well, it’s based off the 10 year treasury yield.

This is essentially what lenders are going to use to base their prices, the prices that they would charge you for a mortgage loan. Lenders typically add about 2% on top of the 10 year treasury yield, and that’s what you as a consumer pay for your mortgage loan. Of course, there’s lots of fluctuation there. It depends on your credit score, it depends on your history, depends on your debt to income ratio.

What exactly is the 10 year treasury yield? Well, it’s just a bond that you can purchase from the government, and when you’re purchasing it, you’re essentially lending money to the government.

And if the future outlook of the economy doesn’t look that great, let’s say inflation is going higher and higher, then what you should expect the government to pay you for lending the money would also go up. So let’s just use inflation as an example. Let’s say right now you could buy a 10 year treasury bond for 5%, but inflation in the economy was 10%.

You would never lend your money for 5% if you knew it was getting eroded by 10% per year. Right? So as the economic outlook changes, those rates go up. And I know this is a little confusing, but basically the most important thing you need to remember is that when the 10 year treasury yields are going up.

mortgage rates will also go up, and when they’re going down, mortgage rates will also go down. You can see in the chart if you’re catching the video version, that that’s precisely what’s been happening.

So the 10 year treasury yield really sets the base for long-term lending. Remember, your lenders banks are going to add usually around another 2%. we’ve also got this thing out there called the prime rate. What is the prime rate?

The primary is usually used for short term loans. Things like your home equity line of credit. Credit cards in general or an auto loan,

and the prime rate is the federal funds rate. With another 3% roughly added on top of it. Remember, if the bank is borrowing that money at the federal funds rate, they’re not going to lend it to you for the exact same amount, or they’re not gonna make any money, right? So typically, historically, they add another 3% to the prime rate, and that’s what you would pay as a prime customer of the bank.

But depending on your credit, that rate could be even higher.

Okay, so with some of the fundamentals out of the way, how do interest rate changes actually affect real estate? Well, they have everything to do with real estate prices. Essentially, if the cost to borrow money to purchase real estate goes up, then that means there are less available people to buy real estate.

Driving the prices down or the demand down on real estate. But when prices on interest rates go down, it’s the exact opposite. And that’s where we are today. They’re dropping and with not a very good job outlook in the future.

They’re expected to continue dropping. This means for every little percentage point that rates go down, millions of new potential home buyers are out there shopping around because we know people aren’t purchasing homes based on how much the home actually costs. They purchase it based on what their monthly payment is going to be.

So higher rates, less demand, lower rates, more demand, which means prices go up.

So interest rates also affect new construction, right? If the cost of construction loans are higher, then less people are going to build new homes because their return is going to be less. But we know that there’s a big lag with new construction. after COVID. Interest rates were historically low and there were lots of people building homes, and that lag is hitting us now.

So a lot of markets, a lot of cities are seeing a lot of new supply coming on, especially in urban areas. And this is driving rents lower, but because interest rates have been really high for the last four years. The new construction starts, or new permits being drawn to build have gone down because investor returns are lower.

So what that means is that there’s not gonna be a whole lot of new supply coming on the market,

at least for the next couple years anyways, if rates continue to go down. Well, the lower the interest rates are, the lower the construction loans are and the more people will build houses, apartments, you name it. One thing that they are not building though, and this is very clear. Is commercial office. We know that this segment of the real estate market has been hit really hard and this is actually another reason that we would want rates to come down because of. All of these commercial loans get foreclosed on and they’re held by banks. Well, it could create a really bad chain reaction, and we know that there’s billions of dollars in commercial loans.

Outstanding.

So good news, the rates are going down. That means that there will be more demand on housing. So if you’ve been on the sidelines and you want to sell a property, there’s going to be more potential buyers. If you want to buy your first property, well your mortgage. Loan payment is going to be lower, but not forever.

Right? We know that there’s a lag here, so you’ll want to get in early. If you’ve got an outstanding loan that has a higher interest rate, I think it’s a really good time to think about refinancing. Of course, we’ll wanna refinance into long term fixed debt, not a variable rate or a short term loan because we don’t know.

How long rates will be down and they are at a historic low. Right now. I know 6% doesn’t sound very low compared to the threes and the fours, 

but if we look throughout history, we are at an incredible time to jump on real estate. If you’ve been sitting on the sidelines.

So a couple quick points, couple action items. Don’t purchase anything if the numbers don’t make sense. Expecting interest rates to continue going down, that’s how you can find yourself in a bit of a hard spot if you do have that property and it’s got a higher interest rate. Well, I think it’s an excellent opportunity to refinance right now.

If you do have a property you’ve been looking to sell, well, it’s not a bad time, and it’s not a bad time to have some equity sitting on the sidelines for when a good opportunity does come up.

And one last thing. It’s never a bad idea to diversify, so if you’ve been looking to get into a new market, well, I think now is an excellent time. Of course, the older you are, the more conservative we want to be.

Well, I know that was a lot of information and when we get into economics, sometimes our eyes glaze over and our brains get a little foggy. But it is important to understand the way that interest rates affect the real estate market. It has everything to do with our prices. So I hope that gave you some good insights, and again, I think it is an excellent time.

I’m excited to jump back into the market. Until next time, I hope you have a fabulous week. Okay.