Interest rates are rising, but there’s no need to panic. In the past, for each 10-basis-point increase in mortgage rates, home sales declined by around 35,000 on a national basis. Since the presidential election, mortgage interest rates have risen by 70 basis points, from an average of 3.5 percent to 4.2 percent.
Rates are rising because faster growth is expected. The Dow Jones Industrial Average has surpassed 20,000, a record high, and the economy is expected to benefit as the federal government cuts taxes, scraps unneeded regulations, and increases spending on infrastructure and defense. Higher growth means we can say goodbye to ultralow interest rates. Look for rates to rise to just below 5 percent over the next 18 months. That’s still low compared to historical patterns: an average of 8.9 percent in the 1970s, 12.7 percent in the 1980s, 8.1 percent in the 1990s, and 6.3 percent in the first decade of this century.
If rising interest rates are accompanied by a strengthening labor market with higher wages, the economy will be fine. At least 2 million net new jobs are forecast for this year, and that is the reason we anticipate home sales will squeak out a modest gain over 2016. If mortgage underwriting standards normalize even modestly from excessively stringent conditions of the past few years, such as through reduced FHA insurance premiums or lower guarantee fees on loans backed by Fannie Mae and Freddie Mac, then sales could be even better.
Some analysts might say higher interest rates are not due to improved long-term economic prospects but to a steep increase in future budget deficits as tax revenue falls and spending increases. If that’s the case, the economic boost will be short-lived, harming home sales in the future.
Which will it be? The task for us is to see how federal policies affect the dynamism in the economy. Fewer regulations will likely encourage entrepreneurs to introduce new products and services. However, if the government instead emphasizes protection of existing companies, then economic growth could suffer.
NAR’s survey of commercial members fortunately indicates openings of small businesses have surpassed closings in recent months. That is a good sign, and some of those small businesses could well become the next Apple, Facebook, or Google. Let the economy work its magic.