The Fed Cut Interest Rates to 0% — What Does This Mean for You?
To ward off the economic consequences of the coronavirus, the United States government just passed a completely unprecedented $2 trillion stimulus bill. In addition, the Federal Reserve has offered an additional $1 trillion each day of March to keep the repo market functioning. Trump administration economist Larry Kudlow said, as such, the overall stimulus would likely come to $6 trillion—the above mentioned $2 trillion stimulus and $4 trillion in lending from the Federal Reserve to various private banks and institutions.
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Amongst these surreal numbers that are being thrown around, the Federal Reserve also cut its benchmark interest rate to a whopping 0.0 percent. The Fed’s discount rate was also cut to 0.25 percent.
What This Means for Lending
These zero percent rates are not for you, of course. The discount rate is the rate at which banks can borrow directly from the Federal Reserve; the benchmark rate is used as a sort of baseline by institutions throughout the economy. As The Financial Dictionary puts it, the benchmark rate is “…the minimum interest rate investors will demand for investing in a non-Treasury security.”
One such benchmark is the LIBOR rate. Private banks will often set their interest rates off of this benchmark. For example, the rate might be LIBOR + 2 percent (or something to that effect). So while the Federal Reserve cutting interest rates to zero means that interest rates are extremely low right now, they are most certainly not zero for you and me.
Even still, the average interest rates being offered by banks on 30-year mortgages were near historic lows earlier this year. Despite the increased economic uncertainty, the Fed slashing its rates should keep mortgage rates low and could drive them lower.
However, even when rates are low, that doesn’t mean that banks will necessarily be lending. Typically, the Federal Reserve dramatically reduces interest rates when the credit market is freezing up. During the 2008 financial crisis, the Federal Reserve also dropped rates to zero and engaged in aggressive quantitative easing—but that didn't stop the recession.
Residential mortgage originations fell by almost 50 percent between 2005 and 2008, and the unemployment rate peaked at 10.2 percent in October 2009. Estimates today are that the unemployment rate could reach between 20 and 30 percent—numbers not seen since the Great Depression.
MarketWatch notes that: "Banks and financial-technology firms are starting to toughen their approval standards for new loans to consumers and small businesses," and, "Loan solicitations by email have dropped for both credit cards and personal loans, according to market-research firm Competiscan."
Banks are also dealing with a large increase in payment deferral requests. Bank of America alone fielded 150,000 such requests this month, and there are worries about the solvency of the mortgage industry long-term if this downturn isn’t short-lived.
That being said, the mortgage industry hasn’t ground to a halt.
My company just closed a $500,000 loan, and from my discussions with several banks, they are still actively lending.
The loans may be harder to get, but the rates are better than ever. Whereas a year or two ago, we were getting rates in the 5 to 5.75 percent range (for those on the coasts, rates are a bit higher than in the Midwest), right now, they’re ranging from 4.25 to 5 percent.
The long-term economic effects are difficult to predict and depend on a lot of factors. But it would appear that, at least for the immediate future, loans will be harder to get but will also provide better rates than before.
Should You Sell?
This is probably not the best time to be selling properties. I’ve heard from several real estate agents that there is still a market for buyers out there, but it seems to be shrinking. We even had one buyer walk on us, and it appeared to be primarily over the coronavirus and its economic fallout.
CNBC reports that home sales could fall 35 percent from what they were last spring! That would make for approximately 2 million fewer home sales. Basically, demand has tanked during this crisis
Of course, if this is a “V-shaped recovery” (which economists are saying is less and less likely by the day), in all odds, the housing market will bounce right back.
Even if it’s not such a sharp recovery, though, whenever this pandemic does end, there will be at least some pent-up demand. So, sales should increase substantially then (although prices will likely be lower than they were in February). When exactly that will be is, however, another question entirely.
For the time being, my recommendation would be to wait on properties that you can wait on. If you have the choice between renting and selling, renting would probably be the better option right now. Yes, if it’s a high-end flip, you’ll likely have to brave the market. But for properties you can hold off on or rent, go that route for now.
For what it’s worth, my company has had almost no drop-off in leasing over the past month.
Should You Buy?
As slimy as it sounds, crises come with opportunities. Warren Buffett, for example, made much of his fortune striking during recessions when assets could be bought on the cheap.
At this time though, I would be very cautious. Interest rates may be cheap, but we simply have no idea how serious this will be and how long it will last. Thereby, it’s best to move prudently and buy more aggressively once the dust has settled.
That being said, there is no reason to turn down great opportunities if they come along. I would just add an extra contingency due to the added risk and uncertainty. If normally you would only buy at 70 percent market value, make it 65 or 60 percent—at least until the economic picture becomes more clear.
Should You Refinance?
I’ve always stressed the importance of keeping strong cash reserves to weather crises and make the most of the opportunities that come up. That being said, it’s not the easiest thing to do for real estate investors, especially in the early going. But if there’s a way to build up those cash reserves now, it’s strongly worth considering.
In the past, I’ve explained that there are three good reasons to refinance, those being:
- As part of a strategy
- To improve rates/terms
- To pull out equity
Right now, both No. 2 and No. 3 would make some sense.
Real estate values are likely going down, but the most important thing right now is liquidity. It’s critical to have cash in case your cash flow is significantly reduced as unemployment makes it impossible for some tenants to pay rent. So pulling out some equity now to increase your cash reserves is likely a good idea as long as it doesn’t substantially increase your overall mortgage payment.
Speaking of which, with rates as low as they are, it may be possible to take out a sizeable chunk of equity and actually reduce your payment or at least tread water. Investopedia recommends that: “It may be wise to refinance if you can lower your interest rate by 1% or more.”
With the benchmark rate at zero, that is likely possible for many.
Again, getting a loan in this environment will be more difficult, but that doesn’t mean it’s impossible by any means. This is another reason it’s important to build relationships with multiple banks. When the going gets tough, some may keep their money sheltered in place, while others will still want to lend. And they’ll particularly want to lend to those they have relationships with.
So going forward, don’t just settle for one banking relationship.
Interest rates are at historic lows and while banks are still hesitant to lend, for many it will be worth trying to provide extra cash reserves and reduce interest rates. Selling right now will be difficult and buying should be done cautiously until the long-term economic consequences of the coronavirus become more apparent.
If nothing else, we certainly live in interesting times.
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