Should I Build a House Now or Wait Until 2023?
“Inflation” has been the buzzword of the past several months, and it’s no wonder why. Even if the mechanisms behind this phenomenon are complex, no one can deny the reality of soaring prices when they fill up their tank or get groceries. Indeed, when prices rise in one place, they’re bound to rise elsewhere. As such, the housing market is vulnerable to these economic effects, too. We’ve seen housing prices increase and continued interest rate hikes. So maybe you should just sit it out for a while until housing prices or interest rates come down? We think not. In this article, we’ll help you understand what’s happening in the market and why now is the best time to buy. But first, let’s talk about those interest rate hikes and what they really mean.
Fed Funds vs Prime Rates vs Mortgage Rates
Interest rates can be tricky for anyone to wrap their head around, especially when there’s more than one type of interest rate to consider. Those looking to build or buy a home will need to understand the difference between the Federal Funds Rate, prime rates, mortgage interest rates, and how all three interact. When the Federal Chairman, Jerome Powell, says they are going to raise interest rates, he is talking about the Federal Funds Rates.
Federal Funds Rates
Just as individuals pay interest to banks when borrowing, banks must pay interest to the Fed when they borrow money from it – this percentage is known as the Federal Funds Rate. The Fed Funds Rate has gone up rapidly in 2022. This time last year, banks were only charged 0.25% by the Fed, whereas this year, they’re charged 2.5%. Without any countermeasures, such an increase in interest rates would put most lenders out of business, so lenders respond by increasing their prime interest rates in tandem.
A prime rate refers to the lowest rate of interest offered by a lender. Borrowers with the best credit histories have access to this rate at a given institution. Moreover, prime rates are meant for short-term lending (10 years or less). While an individual bank sets its own prime rate, the rate they choose is dependent on the Fed Funds Rate described above. When the Fed Funds Rate increases, so too do prime rates, as the only way for banks to stay in business is to increase what they charge borrowers in accordance with the amount of money they’re borrowing from the Federal Reserve. As a general rule, prime rates are about 3% higher than the Fed Funds Rate.
Mortgage rates, on the other hand, take a long-term approach (15-30 years) and are therefore more stable, generally speaking. Note, however, that mortgage rates tend to vary from lender to lender. Moreover, mortgage rates are more strongly influenced by the bond market than the stock market (and the stock market is inversely correlated to the Fed Funds Rate). Put simply, when interest rates go up, the stock market takes a hit as investors put more money into bonds than stocks. When this happens, mortgage rates decline due to a shortage in demand (more mortgages must be sold to see a return on investment). The reverse is true, too: when less money is invested in bonds and more is thrown into the stock market, fixed mortgage interest rates ramp up to slow down the higher number of mortgages being given.
How They Work Together
The economy at large is always in flux, and the Federal Reserve can adjust the Fed Funds Rate in short order, affecting prime rates everywhere. Mortgage rates, however, are not directly affected by Fed Funds so you need to be watching those separately. A good place to do that is at BankRate.com.
Better to Build Now or Wait Till 2023?
So now that you understand interest rates. You're probably still wondering whether its better to build now or wait till 2023? Here are two important considerations:
The first consideration is: can you afford it? Before you do anything shop around for a lender to understand what building a home now means to your monthly cash flow. Remember that mortgage rates differ from one lender to the next and that individual mortgages are in part determined by personal factors such as credit score, down payment, loan-to-value ratio (LTV, which reflects how much money you put down compared to the size of the loan), and more. As you research mortgage lenders, always compare Annual Percentage Rates (APR), as this represents the actual cost of the loan. Ultimately, you want to be comfortable with the payments.
Second, keep in mind that real estate is a long-term investment – the only of its kind that can yield significant returns with little to no money down. Taking the big picture into account, home prices trend upwards over the long term. I’m not talking 3 to 5 years, I’m talking 10, 20, and 30 years. While home prices have increased 18.6% in the last year (according to the Case-Shiller U.S. National Home Price Index, this is not the norm. And the housing downturn in 2009 was also not the norm.) Home prices historically average three to five percent depending upon the neighborhood.
If you would like to build a home and can afford it, there is no time like the present. Start by getting pre-approved with a lender that offers construction loans that work with your budget and long-term goals. From there, work with a home-building company you can trust. Residents in Madison, WI, rely on Sugar-Creek Homes for custom home builds, basement finishes, and more.