Consumers who are less experienced with home buying and financing might think that today's interest rates are the norm. In fact, real estate was a lot different just a few decades ago, when volatile interest rates infiltrated the housing market.
The Reality of Mortgage Rates in the Mid-1980s
Ask someone who was around in the ‘booming 80s,’ and they'll tell you that one thing wasn't booming — the housing market. In those years, interest rates were continually ratcheted up until they were well above double-digit figures.
The market hit rock bottom in the early part of the decade, when real interest rates for mortgages spiked to around 18 percent, making it more difficult for potential home buyers to purchase a home. In turn, the low demand for homes caused builders and construction companies to fall into a slump.
Why Did High Rates Occur?
According to economic experts, the rise in interest rates was caused by inflation, the government’s response, and responses by lenders.
First, lenders wanted to be compensated for inflation. Lenders thought that inflation was going to happen quickly and systemically over time, so banks and other lending companies wanted a return on their money that was going to beat inflation. That meant borrowers had to pay more interest.
In the 1970s, inflation was running rampant. Interest rates kept increasing while lenders also looked at the credit worthiness of borrowers, which hiked some individuals' interest rates up even further.
Over the same period, the government was raising the federal interest rate. Since consumer loans are based on the Fed's bank rates, this pushed mortgage rates up even higher!
Contrast that picture with today: The Federal Reserve's response to the economic crisis of 2008 was to continually slash interest rates to historic lows. Current lenders are offering interest rates at nearly zero percent, while governments and banks are lending to each other at rates close to zero, and consumer rates for mortgages have been dipping below 4 percent.
To paint a clear picture of how this change in interest rates affects your home prices and home payments, take a $100,000 house. At 4 percent interest, a borrower will pay $4,000 a year. At the 18 percent rate of the 1980s, that same borrower would have been paying $18,000 in that same year.
A 30-year amortization schedule shows that, with a higher interest rate, consumers ended up paying many times what their homes sold for over the years. With an interest rate of around 5 percent, a borrower might only pay double the sale price or less, especially if you can pay off some of the principle early.
Today's market offers a tremendous opportunity for getting a mortgage or refinancing. Potential homebuyers have the opportunity to get a cheap loan and buy the home of their dreams. Current homeowners have the opportunity to refinance into a lower mortgage payment and save a ton on interest expense.