With some real estate experts predicting mortgage interest rates of 5.5% or lower in 2025, we wanted to look ahead to how the market will likely react to such a drop.
Rates at this level would likely usher in the new normal. Long gone are the days of 3% mortgage rates. But with inflation slowing, we no longer need the 7.5%+ rates we saw in 2023.
So how do we navigate this shift to the new normal? Here’s what we expect to see as mortgage rates decline toward 5.5%.
1. A Surge in Refinancing
Property owners who got locked into higher rates by purchasing in late 2022 through early 2024 are just waiting for rates to drop so they can refinance to a lower rate. This wave of refinancing could give the entire economy a boost by reducing mortgage payments and giving owners more disposable income to spend elsewhere.
Prepayment Penalties, Closing Costs, and Refinancing Decisions
Of course, refinancing only makes sense when the interest savings more than offset the costs associated with originating the new loan, plus any prepayment penalties on the existing loan.
To calculate the breakeven point of a refinance, divide the total refinancing cost (including any prepayment penalty) by the monthly mortgage payment savings. This will tell you how many months it will take for the savings to exceed the expense. You’ll need to hold the property under the new mortgage for at least that long to benefit from a refi.
2. Alignment of Rent and Interest Rates
With rates falling, landlords and investors may need to adjust rental prices to reflect the lower borrowing costs.
In many cases, when interest rates fall, homeownership becomes more accessible, so more people buy and fewer people rent. However, in high-value markets like Los Angeles, so little of the population can afford to buy that renter demand continues to be high.
The alignment process should be considered before acquiring or selling properties. If rents decrease to reflect lower interest rates, it might make sense to hold the property for a lease cycle or two until rental agreements can be signed with higher rental rates to encourage buyers to pay more for the investment property.
3. The Golden Handcuffs Come Off
Many property owners who purchased their assets between 2012 and early 2022 have the fortunate problem of being locked into sub-5% interest rates. Someone who locked in a 3% rate in 2020 (through a new purchase or refinance) hasn’t wanted to sell their primary residence despite strong appreciation and corresponding equity increases in most markets. These owners know that selling means giving up that rate and accepting a much higher rate on the purchase of a replacement property.
Economists call this problem golden handcuffs, alluding to the fact that owners are trapped by something of value.
But as rates drop, the financial impact of giving up an old mortgage to take on a new one isn’t as severe. This means more owners may be willing to sell, which is good news for buyers who have been struggling with low inventory for years.
Navigate the Shifting Market with Gatsby Investment
Real estate markets are always changing, but they rarely do so instantaneously. It could take 6-12 months for the full effects of this new normal to be felt. During this transition period, we will see gradual changes in refinancing, rental prices, and new listings.
Gatsby Investment diligently monitors the market to stay ahead of changing conditions for our investors. Whether rates are rising, falling, or stabilizing, we are continually tweaking our strategy to take advantage of the current economic climate.
Leverage our market expertise for your real estate portfolio. Explore our available investment opportunities and let us take care of the details for you!