Interest rates, inventory and home values in the New Year

By every metric, 2021 was a whirlwind year for real estate and mortgage lending. Of course, if you live in northern Michigan, you probably already knew that.

Our local housing market has rarely been hotter. You didn’t have to go far this year to hear tales of bidding wars, homes selling way above asking price and properties being scooped off the market within hours of listing. And even though we saw the market start to cool down this summer, that hardly means the boom is over.

According to Aspire North, Grand Traverse County tracked 161 home sales in July of 2021, compared to 216 in July 2020. Meanwhile, the average sale price of homes in July was $440,437, up 22% year-over-year.

The story these numbers tell is a simple demonstration of economic laws. The northern Michigan housing market spent much of 2021 scraping the bottom of the inventory barrel. There weren’t many existing houses hitting the market, and new construction wasn’t moving fast enough to respond to the shortage. Limited supply meant that sales numbers dropped, but as is always the case in low supply/high demand situations, prices for the homes that were on the market skyrocketed.

The supposed “cooling” of the residential real estate market in Traverse City isn’t the only incidence of the numbers suggesting one thing on the surface but saying another in context. A similar phenomenon is playing out with mortgage refinancing.

One big trend in mortgage lending in 2020 was the way that historic low interest rates from the Federal Reserve were generating huge demand for refinancing. A lot of people took advantage of the rates as a way to reduce their monthly mortgage payments.

The initial rush to refinance was satisfied by late last year, but even now we’re still seeing refinancing activity. It begs the question: Why did the people getting their refi applications in now wait over a year and a half to take the plunge?

The simple answer is that interest rates remain attractive. The more complicated answer is that refinancing trends are a reflection of current market dynamics. Homeowners who may have expected to upsize or downsize from their existing homes in two to three years are seeing what’s happening in the market and deciding to stay put for the long haul.

Put another way, the inventory shortage is now so severe that would-be sellers are deciding to hold onto their existing homes for longer – which could spell even bigger challenges for local inventory going forward.

What will happen to inventory in the New Year? What about local home values? Those are two of the three big questions that local home buyers should be eyeing as we enter 2022. The other question has to do with the Federal Reserve board and how it will approach interest rates going forward.

Right now, the Fed is in “stimulate the economy” mode. But there is always fear in times like these of sending so much money out into society that it causes inflation. As we speak, there is almost certainly a debate at the federal level, weighing the pros and cons of keeping rates where they are – and raising the debt ceiling to allow this period of economic stimulation to continue – or raising rates to choke off inflation. The concern is what happens if this era of low rates shifts suddenly in the opposite direction.

I got into real estate in August of 1979, which happened to be the month that mortgage rates hit double digits for the first time. The prime rate was in single digits the entire century, but a period of high inflation through the ’70s led the Fed to institute policies – from 1979 to 1983 – aimed at choking off the economy and slowing inflation. And so, interest rates rose, and rose, and rose. By 1981, prime was 22%. Picture that today, at a time when people are used to hearing rates at 2-4%.

Most of the current generation is not ready for that kind of shift. In the 1980s, we still had lots of children of the Depression, children of World War II. These were not today’s consumers. There were people that, in many cases, had been told by their parents, “Don’t spend, don’t borrow, don’t take.” Now, we’ve spent the better part of the last 40 years teaching people how to leverage other people’s money to have a good life. That means, if interest rates go up suddenly, it will shut people off from how they’ve been taught to live. They’ve been taught the lesson of, “Money is cheap, use it.” And when money gets to be expensive, that’s when things go bad.

One of the reasons we’re seeing housing prices shoot through the roof is that money has been cheap. When rates were 8%, you couldn’t afford to borrow as much money, which meant you bought less house. But with rates at 2.5-3%, the person who could only afford to buy a $200,000 house before could buy a $325,000 house now. And they did.

Bottom line, rates are eventually going to increase to stem inflation. When that occurs, what happens to home values? What happens to these houses that have sold for way above asking price? What happens to people when they go to sell their houses and can’t command the same prices they paid for them? Or when a homeowner has to refinance their home because of a divorce, or the death of a spouse or for any other reason? Foreclosures become a risk; selling a house for way less than you bought becomes a risk; a collapse of the market becomes a risk.

One silver lining is that our market is unique. Tourism, retirement and quality of life insulates us from many market swings, because buyers are always coming here with lots of cash and a willingness to pay handsomely for local properties. As a result, when there are bad times in the market, we’re typically the last one into them. And when there are good times, we’re the first one out of the bad times.

Still, I’d urge caution. Maybe think twice before buying way above asking price, or before making a huge down payment, or before paying down your 3.5% mortgage more rapidly than the bank requires. Because ultimately, if rates get raised, there will be winners and there will be losers. The winners will be people with cash in the bank, and the losers will be the ones who have to borrow.

Mike Nagy is vice president of mortgage lending at State Savings Bank in Traverse City. He has more than four decades of banking experience. State Savings Bank has been financing homes in northwestern Lower Michigan since 1901.