This does concern you
This week, I met with a seller who had a beautiful, brick ranch in a very desirable subdivision in Calhoun. The house was in very good shape. It needed some updating since it still had original fixtures throughout the house as well as wallpaper from its construction era. The kitchen needed some love too, but it had nice hardwood floors, a great living space and a well-manicured yard.
The seller’s situation was that they were in their 80s and the maintenance on the house was becoming too much for them. They had experienced some health issues as of late and had decided they should sell their home and move into a retirement community.
I always ask the sellers what they plan to do with the money. This is a good tactic because if they say they are just going to put it into a savings account, you may be able to structure an owner financing deal. These people needed the funds, however, so they could finance the costs of living in their new community.
I went ahead and made them a cash offer. As we were talking about it, the wife said something I believe you should be prepared for. She pointed out that the house across the street sold just a few months ago for an excellent price. I tried to caution her on looking at houses that sold earlier in the year because the Federal Reserve just raised interest rates. And that means we could see a shift in the market because fewer people will be able to qualify for a loan now. She replied, “Buyers that can’t qualify does not concern me. I just need to sell my house for a good price.”
She did not understand how the rate change can affect her ability to sell a house because of what it could do to the buyer pool. So today, I’d like to show you why rate changes should concern you. And we are going to use a financial calculator to do it.
And just to remind you, a financial calculator has five buttons up top. They are: N – number of payments (in months); I/YR – interest/ yearly return; PV- present value of the loan or investment; PMT – payments; and FV- future value.
In order to use a financial calculator, you have to have four pieces of information from the list above, and then the calculator will solve for the fifth. So, let’s find out how much a person’s payment would be if they bought a $350,000 home earlier in the year.
According to themortgagereports.com, the average 30-year fixed mortgage in January of 2022 was 3.45%, which was up nearly half a percentage point from what we saw in 2021. Plugging that into the calculator, your buttons should look as follows:
N=360, I/YR= 3.45, PV= $350,000, PMT= ? (that’s what we are looking for) FV=0 because the loan pays off.
Solving for PMT, and you get $1,561.90 a month. (Note: this will be a negative number in your calculator because the money is going away from you in the form of payments to the bank. A positive number means the money is coming to you like if you were a note holder.)
So, in January, someone that could qualify for $1,561.90 payment, could buy a $350k house. But the interest rate just went to 6.1% in June 2022. Armed with that information, and leaving all but the interest rate the same, we can calculate how much a person can pay for a house at the new rate. To do that, change I/YR to 6.1, and the solve for PV.
N=360, I/YR= 6.1, PV= ?, PMT= 1,561.90 FV=0
PV= $257,742.16. That means someone in January who could buy a $350,000 house now can only purchase a $250,000 house today. Their buying power just went down nearly $100,000 because of the interest rate change.
Try doing the same calculations with PVs for house prices of $300,000, $250,000, and $200,000. You’ll find out quickly that buyers just lost the ability to buy the houses they were looking at in January and may not be buying at all now.
If you’re flipping houses, this should really concern you because one of two things has to happen. Either the buyers will have to qualify for a higher payment, or you’re going to have to reduce the price of your house — and with the increasing price of gas, along with the cost of goods and services, I just don’t see the buyers qualifying for higher payments.
Either way, the market just shifted, and the time of multiple, over-list price offers and fierce buyer competition is ending. You need to make sure you take this into consideration when calculating your after-repair values and what your purchase offer should be. I suggest you be very conservative until we can tell which way this wave is going to go.
Joe and Ashley English buy houses and mobile homes in Northwest Georgia. For more information or to ask a question, go to www.cashflowwithjoe.com or call Joe at 678-986-6813.
That was really informative. Thank you for sharing
I always appreciate how you break things down so I understand how the calculations are made.