What should real estate investors think about the 5 percent test?

The five percent test, as in, 30-year fixed rate mortgages of 5% or greater, is being touted in the media as a potential deal breaker for the real estate market. This is because, in recent memory, as in since the end of the Great Recession (2009), fixed rate mortgages have been less than this “benchmark” rate. Thus, real estate prices have risen and mortgages are more affordable at these lower interest rates (the monthly payment is lower).

However, the general media is ignoring the fact that, for the majority of the time that this value has been tracked by the Federal Reserve (since 1971), the 30-year fixed interest rate has been higher than 5% (and some of that time significantly higher than 5%). In fact, the Average rate over this time period (1971-2018) is actually over 8%! What this tells me, is that the 5% test is not a test at all, and that if I was in the market for a new house, or considering a move to a different part of the country, a 5% 30-year mortgage rate would not deter me from making that decision.

Other considerations in your thinking should also include the economy, the stock market, and inflation. The economy is a significant factor, in that if the economy stays strong, then the real estate market will remain strong and prices will continue to rise (and so will interest rates). If the economy weakens, then the Fed will be forced to lower interest rates to boost the economy, providing you an opportunity to refinance at a lower rate.

The stock market is also a factor, in that if the stock market stays strong, then people will feel rich and will still want to invest in real estate. If the stock market falters, then the next logical investment vehicle will become real estate, which will drive prices higher. Finally, if inflation makes a comeback, then your best investment will be real estate, because real estate is one of the best inflation protection investments out there (for the majority of the population).