Reading through all the news about whether the Federal Reserve will change
interest rates might make you think the Fed has more power than it does. Don’t get me
wrong; the Fed has enormous influence on America’s economy. But sometimes people
mix up a correlation with causation. That is, they assume changes in federal interest
rates will have a direct effect on mortgage rates.
To understand correlation versus causation, let me give a common example. At
one time, people noticed that when there was an uptick in ice cream sales in New York
City, there was a corresponding uptick in deaths in India. Should ice cream be banned?
Were New Yorkers inadvertently killing innocent people across the ocean with their
choice of dessert? Clearly not.
The right question here is: What are the factors contributing to each of these
circumstances and how are they connected (if they are)? NYC has hot summers and ice
cream is a cool, tasty treat. In India, that same time of year is monsoon season, a time
when unpredictable rains cause dangerous flooding, leading to a higher death rate. So,
the two occurrences are correlated because of weather, but ice cream sales have no
impact on Indian death rates.
When it comes to mortgage interest rates, the question of correlation versus
causation is a little more subtle, but relevant nonetheless. The Fed’s job is to promote
maximum employment and keep prices stable, and it uses monetary policy to do so—
the discount rate being one of its favorite tools. The discount rate is the interest rate
charged to commercial banks on loans they receive from the Fed. Oftentimes, there’s a
correlation between the discount rate and mortgage rates, because commercial banks
pass on their costs to customers.
Here's what many people miss: it is financial markets that determine mortgage
rates, not the Fed. The Fed is supposed to be apolitical, but I think it’s fair to say that
even the Fed feels some political pressure.
Given that virtually all presidential administrations love low interest rates because
low rates make them look good, if the Fed lowered the current discount rate from 4.50%
(the rate when I wrote this) to 2.50% (the rate from a couple of years ago), the
marketplace would not believe that was the right action. In fact, financial markets would
likely see the move as inflationary. Long-term interest rates are far more attuned to
inflation than they are to the Federal Reserve discount rate. If the Fed lowered the
discount rate in an attempt to control the market, it would fail. The market would see the
move as inflationary, and that would actually cause interest rates for 30-year, fixed-rate
home loans to go up, not down.
I cannot predict what interest rates will be in six months or a year, but I can tell
you that the marketplace currently seems to think rates will remain stable or go up
slightly, based on inflation predictions. Whether you support the current administration
or not, Donald Trump and Elon Musk appear to be cutting significantly from the federal
budget, which will likely lower long-term inflation. (Of course, the way they are cutting
may cause other problems, but it’s hard to know whether or how those problems may
affect inflation, notwithstanding the current tariff wars.)
So, let’s come to the point: When is the best time to buy or sell real estate? Keep
in mind that while inflation has a direct impact on long-term mortgage rates, it also has a
direct impact on the future value of any real estate. If you’re buying today and paying a
high interest rate because inflation is high, the value of your property is also going up.
One offsets the other. On the other side of the coin, if you postpone a purchase, then
the rates may be lower but you’re likely to pay a higher price.
Ideally, you want to buy when prices are low because even if interest rates are
high, you can refinance when interest rates drop, as much of the country did a few
years ago. This is why so many people are holding mortgage loans at 2.5%. If the
interest rate on your home loan is fixed and inflation drives the value of your house up,
your monthly payments don’t go up and you’re a real winner. Historically, this is how it
has worked for homeowners.
If you have questions about property management or real estate, please contact
me at [email protected] or call (707) 462-4000. If you have an idea for a future
column, share it with me and if I use it, I’ll send you a $25 gift certificate to Schat’s
Bakery.
Dick Selzer is a real estate broker who has been in the business for more than
45 years. The opinions expressed here are his and do not necessarily represent his
affiliated organizations.
