If you're in the market to build a custom home, the chart of average 30-yr mortgage rates in the US looks scary. Never before have interest rates climbed so fast and so aggressively. Building a new home has enough risks by itself, but adding in rapidly climbing interest rates it becomes a wholly unpredictable and unattractive endeavor. But with uncertainty comes opportunity - in this post we'll share our outlook on the timing of interest rates and some helpful tips on taking advantage of this environment to come out ahead when planning your dream home.
Where are Interest Rates Heading?
Before we dive into trying to predict the future, let's color some background on monetary policy:
There are many who think that we are looking at a repeat of the stagflationary 1970s but we think that this time is a structurally different scenario because the neutral interest rate (R*) is significantly lower than it was (primarily due to demographics). This means that a significantly lower interest rate can be just as tight as it was back then. Unless inflation expectations become unanchored (there is no sign they have been) then interest rates should soon find a peak and come back down again. It's impossible to say exactly where this will happen but markets are pricing in a peak in FFR rates around March of 2023. The speed at which rates come back down is dependent on the trajectory of the employment market and inflation. If the futures market is right, we should currently be at or near the peak in mortgage rates.
How to Time It?
The good news is that higher interest rates are scaring off many potential home buyers which will force home builders and contractors to drop their prices over the next year or two. Over the past two months, we've already seen prices start to decline. This decline in prices will likely continue to pick up until the early spring when building cost seasonality tends to pick up.
The bad news is that higher interest rates make your home less affordable, so unless you're building with cash, you will have to settle for less.
- Look into phased construction, and take advantage of unfinished spaces like bonus rooms and basements to drive down upfront costs but allow you to get everything you want in the long term.
- Take advantage of the softer construction market and the likely longer term downward trajectory of interest rates to buy in when the construction market softens and then refinance when interest rates normalize.
- No matter what, make sure that in the unlikely event that rates do not normalize, you can still afford the mortgage!