A Major Drop in Interest Rates is Actually the LAST Thing We Want. Ok, I said it.
Interest rates are one of the most critical influencers of the real estate market. When rates suddenly and significantly drop, it creates a ripple effect, impacting buyers, sellers, investors, and the overall market—both in the short term and for years to come.
I’ll tell you a little story about what it looks like when those rates drop like flies…
It was 2020, and the whole world shut down. The economy was in danger, the world was terrified—I mean people were seriously going to the grocery store with baby diapers on their faces like ski masks for Pete’s sake. We needed a fix—and fast. So, the FED cut rates to alleviate some of the consumer pain of spending, making it easier to do so. In a super short period of time, mortgage rates dropped from almost 5% to well below 3%.
…and well…the real estate world almost literally exploded.
I sold 94 homes from January 2020 to December 2021. Yes. Nine. Four. Almost 100. The average agent in our area before that time sold just 2 homes per month, if that.
Those 2 years were the closest to the Wild Wild West that I’ll probably ever see, and I’m just fine with that because boy was it CRAZY. Sellers were making out pretty well (luckily, I was primarily a Listing Agent then), but boy was that market tough for buyers.
My record number of offers received on one listing was set then: 52. Yes, within three days’ time, my sellers and I had 52 competitive offers to analyze—and we could only choose ONE. So that meant that 51 other buyers were off to compete for the next available listing.
Wanna know how buyers won those competitive situations? Cash. They overpaid for properties by tens of thousands of dollars, waiving appraisals or bridging the gap between the appraised value and what they were willing to pay for it.
And I’m a millennial, so I can say this with no offense…I heard once that we are the “Nintendo” generation, meaning that people our age are always looking for a secret shortcut to get us somewhere farther & faster. Well, that works in video games (don’t challenge me in Mario Kart–you won’t win ;), but it doesn’t always work in real life.
Here’s why—in the real estate world, at least. I can think of five short-term niceties that, after five years, no longer play well in the sandbox with others…
1. Increased Buyer Activity
Lower interest rates reduce borrowing costs, which of course makes homeownership more affordable—it’s easier to qualify for a mortgage with lower rates, and since lower rates mean lower payments, buyers can afford higher price points. That’s all well & good now, but what happens in five years when you’ve outgrown the house you bought—and likely paid over list price in order to win the deal?
Think back to what happened in 2020 & 2021 when those great rates were around. And boy were they great!! And if you bought in 2019 and refinanced below 3%, you’re sitting pretty now! But…
- Increased competition meant buyers were paying over and above list price, just to win the deal…which created “comps” that increased list prices for the next few years—and not by just a few percent…
- First-Time Home Buyers got the short end of the stick, as cash to close increased at a faster rate than ever…Then interest rates normalized but pricing didn’t go down, so it got even harder to go from renting to buying. From 2019 to 2024, the average age of first-time home buyers increased by five years. That means that if you turned 30 in 2018 or 2019 without having bought a home, each year that goes by, you’re an additional year away from homeownership. That’s a hard pill to swallow.
- This created a sustained Seller’s Market that’s just now plateauing, after five years of Buyers struggling in the search. Now, the competitor in me wants to think, “Ok. Come on down, interest rates, I’ll get in this time and have the mega fast appreciation rate this go’round, and five years from now, I’ll be on the winning side!” No. Unfortunately, I don’t see things happening like that again for a long, long time, if ever. Just like the Crash of ’08 caused major changes in the lending industry, the wild wild west of the 2020 Pandemic likely caused major changes in the Fed’s ways of handling interest rates…So if your thoughts were similar to the one I just described, go back up to the bullet point above this one and read that again…Only this time you won’t be a first-timer—you’ll just be a seller selling to become a buyer who’s making a lateral move, spending more to buy something pretty similar to that “win.”
2. Refinancing Booms
A sudden drop in interest rates often leads to a wave of refinancing as homeowners take advantage of lower rates to reduce their monthly payments. Who can blame them??
- The average time spent in a home before selling will increase, which brings the issue we’ve experienced since 2022: low supply. And instead of high demand, we’ll have Buyers sad that they missed out on the low rates and refusing to buy until they’re back down again…Which of course means a stagnant market, and—well this is a blog for another day, but—the real estate market is one of the largest drivers of our economy, believe it or not.
- Changes in lending practices as banks adapt to higher volumes of refinancing applications. Want to know the biggest change I saw? Banks began focusing so much on refinancing that they lost their “groove” in actual purchases, and many reputations were ruined as a result—and both buyers and sellers suffered from the repercussions.
3. Shift in Investor Strategies
Lower rates also impact real estate investors, altering their strategies and expectations for returns. Long-term effects may include:
- Increased activity in the rental market as investors capitalize on low borrowing costs to acquire properties. This is perhaps the most heartbreaking piece to me. Investors have more purchase power than in a market with higher rates, and they are typically able to make an offer that’s more appealing to a seller than a first-time home buyer…Therefore widening the gap between renting and first-time home buying.
- Decreased consistency in neighborhoods and local markets. More investors means less predictability in atmosphere—with neighbors that change yearly or more frequently, that brings a higher uncertainty to buyers, which means a longer decision-making process, which means a longer time on market for listed homes.
4. Economic Stimulus and Risks
A drastic rate drop can act as a form of economic stimulus, encouraging spending and investment across the board. However, the long-term effects can be double-edged:
- Positive: Increased economic activity and wealth generation as property values rise and homeowners feel more financially secure.
- Negative: Risk of creating asset bubbles if property prices inflate too quickly, potentially leading to a market correction or downturn when rates eventually rise.
5. Changing Home Buyer Expectations
When buyers experience an era of low rates, it often resets their expectations for what’s “normal,” and this is unfortunately where we are today.
- Difficulty adjusting to higher rates when they eventually return, which could dampen demand. And don’t get me wrong—it’s not just the higher rates that cause the hesitation—it’s the higher rate coupled with the higher prices. If we’re weary of today’s combination of the two, imagine what will happen if there’s a repeat of 2020-21.
While a sudden drastic drop in interest rates seems appealing, that appeal really is limited to the short term, unfortunately. The long-term effects can and likely will span farther than the five points I’ve mentioned here, and I don’t know about you, but I don’t really want to experience anything more discouraging than the latest downturn. I can only imagine that it would be exponentially worse.
My thoughts in a nutshell:
Are lower interest rates better? Yes. Do I hope they settle out well below where they are now? Yes. But do I want that to happen overnight? No. The trick to winning this game in the long run is patience. Let it happen over time, and continue purchasing with a forward-thinking mindset.
Buying now doesn’t mean paying today’s interest rates, you know. Perhaps that’s a blog for another day also, but in the meantime, you know where to find me if you want in on the secret
