HOW YOUR RENTAL PROPERTY INTEREST RATE IS CALCULATED
It’s not just speculation anymore…interest rates are going up. In mid-June, the Federal Reserve raised the interest rate by .75%, the largest single hike in almost 30 years. The goal is to slow the pace of inflation and with that effort comes an additional barrier to entry into the housing market. While housing prices remain sky-high, average fixed mortgage rates are almost double what they were a year ago. Last year you were looking at somewhere around 3.2%; in the second half of 2022, you’ll be happy to find a rate under 6%. But how do your local lenders come to these numbers? In other words, it’s easy enough to follow the sobering news regarding monetary policy, but how are rental property interest rates actually calculated? The more you understand, the more you can appreciate your place in the system.
A VERY QUICK DISCUSSION ABOUT MORTGAGE HISTORY
During the Great Depression it was obviously quite difficult to get a loan and just as difficult to find a financial institution you could trust. In 1932, the government created a system of regional, government sponsored banks, to help create reliable streams of cash to other banks and lenders for financing housing and other infrastructural projects. Today, there are 11 of these regional Federal Home Loan Banks that provide funds to financial institutions, all under the supervision of the Federal Housing Finance Agency.
[LEARN MORE: MORTGAGE RATES OVER THE LAST 50 YEARS]
YOUR LOCAL LENDERS
If you’re in New England, it’s very likely that any lender you seek to work with is checking in with the Federal Home Loan Bank Boston (the closest regional FHLB) and keeping track of their rates. Like any market, rates fluctuate throughout the day, but the FHLBs all have easy to find average rates that are important to lenders. Local lenders will look at the 5-year rate and use that as a basis for the mortgage rate they might offer you.
Today, June 28, 2002, the 5-year rate is 3.53% (It was 3.16% just two months ago). That number probably looks very attractive to you, but unfortunately, it’s not for you. That rate is the figure at which other banks can borrow from the FHLB…the rate the bank is getting their money at.
Direct lenders can borrow at that rate but will then add “basis points” to that rate. As is always the case, the middle man gets his cut, and in this system, the basis points are the amount of money your bank is going to profit by lending to you. If a bank offers 225 basis points, that is equal to 2.25%. They then add that to the 5 year rate from the FHLB (3.53%) and the mortgage loan rate they offer you will be…5.78%. To check our math, the national fixed rate mortgage average (on homes less than $647,200) is currently 5.84%...it looks like a lot of lenders are looking for about 225-230 basis points.
[LEARN MORE: CASH IN ON YOUR RENTAL PROPERTY BEFORE THE HAMMER DROPS]
IS THERE VARIABILITY?
Short answer: almost always, yes. That’s a staple of a capitalist system. Every bank is different and can set basis points to their preference. What is helpful to know is that banks will typically align their basis points to their strengths and preferences. For example, a lender who prefers to work with single family homes might set basis points on a multi-unit investment property closer to 300-315 basis points. It’s not in their wheelhouse so there’s greater friction, more work to be done, so they’re going to price it accordingly. On the flipside, there are many lenders out there that specialize in and prefer rental apartments [Check in with your local Nexus office to find if there are any that service your area]. Those banks or credit unions might offer closer to 200 basis points because that’s the business they want to attract. They’re offering a smaller spread because that’s their bread and butter.
FIND A SPECIALIST
The key is to find a specialist, a lender that is experienced and wants to do what you’re asking for. As Greg eloquently puts it in the video above, “If you go to McDonald’s looking for a hotdog, they might have one, but I probably wouldn’t eat it”. Don’t go to a bank for a mortgage because you already have an open checking account with them. Don’t go to a bank because a relative works there. Don’t go with the guy who coaches your son’s soccer team. Don’t go to the bank just because it’s close to your house…Do your homework, reach out to trusted real estate professionals in your area, and take advantage of the opportunity to save yourself some money and get better service than you’d find elsewhere. Then continue to build that relationship so you can benefit the next time around as well.
[LEARN MORE: HIRE A SPECIALIST, NOT A JACK OF ALL TRADES]
There’s a system and it starts with the people who have the money and it ends with you, the person who needs the money. Everyone along that track is going to get their cut and there’s not much you can do about it, but it certainly helps to better understand the system. That understanding also helps you as a property owner as you can then fully appreciate the extension of your tenants to the bottom of that system, where they then service you, and your cut.
Interest rates are fluid and will continue to move with the ebbs and flows of the economy as they have for the last 50 years and beyond. With a long-term approach to investing and an eagerness to build relationships and learn from the real estate professionals in your area, you’re in better shape than most when it comes to swimming these choppy waters. Investment opportunities will improve in time, and you’ll be ahead of the game by better understanding the more challenging circumstances we currently find ourselves in. Reach out to our Nexus team if you have any questions or want to discuss specific opportunities. We’re always here for you and any other future Nvestors.
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Mick Lefort is the Vice President of Operations for Nexus Property Management®. A National Property Management Franchise that manages all types of rental property from single family homes or condos to large apartment buildings and complexes.
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