As of April 5th, interest rates have been falling which is leading to a resurgence of refinancing in the housing market. Why is this and what effect does this have on the appraisal industry? Interest rates have a profound effect on supply-and-demand, capital flows, and investor’s required rates of return on investment.
When interest rates drop, borrowers save money on refinancing their homes which encourages consumer spending for big purchases like houses and cars, thereby helping to expand the economy. Appraisal volumes will also increase in the mortgage refinancing sector as a result of greater spending in the real estate market.
Rising interest rates makes it more difficult to refinance commercial real estate loans because property valuations become more expensive in response. As a result, commercial real estate appraisals have lower value. It becomes more difficult to renew or refinance conventional mortgages when appraisals are not valued as highly
The relationship between the fluctuating value of appraisals and interest rates is a bit of a two-way street, as appraisals determine the LTV, or loan-to-value, ratio and a lower ratio can also help the borrower acquire a lower interest rate for a house. This is because the lender sees the loan as less of a risk to take on than a property with an LTV ratio above 75% for example.
If the appraisal valuation is done well and matches with the borrower’s expectations, it is possible for him or her to secure a lower interest rate for the property. It could be even lower if the appraisal determines the home has a higher value than what the bank determined it was worth.
When a mortgage is secured, the home-buyer wants to secure as low of an interest rate as possible while negotiating with the lender. Changes in the interest rate, even small changes like 0.5 points in any direction, can greatly affect how much of the borrower’s payment goes back to the house and how many people with lower incomes are able to enter the housing market based on their ability to pay.
The market usually sees an upsurge in activity when there are signs that the Federal Reserve is about to increase interest rates and consumers want to take advantage of the lower rates before time runs out.
As the interest rate can fluctuate on a daily basis (and even multiple times throughout the day), lenders recommend that borrowers take advantage of a rate lock so that while a loan is being finalized, they will still be paying the lesser rate they agreed to even after it has already increased in the market, say 4.5% when it otherwise went up to 4.8% as an example.
The rate lock isn’t permanent however and should be implemented within a reasonable time frame of the deal’s completion; do it too early and the rate lock will expire, meaning the borrower might have to pay the higher interest rate unless he or she decides to extend the rate lock, usually with a fee.
When borrowers are able to secure a low interest rate for their mortgage, appraisals increase in value because the borrower has higher purchasing power and is able to devote more of his or her budget to paying off the loan amount.
Dropping interest rates can also provide an indicator of the available home inventory because it impacts the ability for consumers to purchase new houses. According to Sacramento Appraisal Blog, low interest rates are keeping homes off the market because current home owners are staying put so as to avoid paying a higher mortgage on a new home.
This presents a catch-22 where current home owners can’t free up space for people who need affordable places to live because of their own concerns regarding affordability in new homes with higher interest rates.
Those who are unemployed may have a difficult experience securing a home because they lack the stable funding necessary to pay down a mortgage, which could have a sizable impact on the economy depending on the unemployment rate. According to a recent article from MarketWatch, the Fed has avoided raising interest rates due to apprehension over domestic and international economic conditions along with low levels of inflation. The Federal Open Market Committee (or FOMC) has stated in a joint meeting with the Board of Governors that it wants to “minimize the risk of interest rate volatility and encourage real residential investment.”
Having high levels of inflation can lessen how far a consumer’s money is able to go towards a mortgage and interest rate volatility can discourage borrowers from investing in a home because they’re uncertain of how much they will ultimately pay for it. When a dollar has less value and less people are willing to invest, that’s when appraisal volumes begin to decrease overall.
It is important that a balance be struck between how much risk lenders are willing to put on for houses and the affordability for borrowers so that appraisal volumes can steadily grow in quantity and value, thereby making a positive contribution back to the economy.