Who's driving the real estate train....?

    Have you wondered why there are so many new homes and condos under construction when inventories are already so high....? It's because the real estate market is like a train that takes a couple years to fully stop or go. If you want to know where the market is going, or how to price your home, it helps to look at who's driving the train....

Let's start by putting a common misconception to rest. If interest rates go up 1 percent, it's no big deal because a 1 percent increase in the mortgage payment is negligible. ( Not really)

Most home loans today are interest only. That means 100 percent of the mortgage payment is interest. So if you have a $100,000 mortgage at 5 percent, you will pay $5,000 a year. When the rate rises to 6 percent, that same $5,000 will finance an $83,000 home. That's a 17 percent decrease in purchasing power.

In simplified terms, that means the collective pool of money available to buy homes decreased 17 percent when interest rates rose just one point. The buyers that were willing to buy a home for $100,000 now only have $83,000 to spend.

    The sellers who understand this, lower their prices accordingly. Those are the homes that sell...! However, confusion is the norm as stubborn sellers slow the market to a crawl.

Now...let's look at what happens when interest rates rise 2 points~ from 5 percent to 7 percent. Now, that same $5,000 in annual mortgage payments will finance only a $71,000 home.( A mere 2 percent increase in mortgage rates has decreased the buyers purchasing power by 29 percent).

Does this have practical applications? Yes, please read on....

Last fall, a home appraised at $600,000. I placed it on the market this spring at $595,000 and got no results...

I then shifted gears and in the months since the home appraised at $600,000, rising interest rates eroded 17 percent from the buyers purchasing power. To offset this, I sliced 17 percent from the appraisal and priced the home at $499,000.

Guess what happened next, you got it! Sold for $497,000 in just 1 week from buyers who were waiting in the wings. ( And the only home in the subdivision to have sold since late 2005.

Interest rates drive this train. We've seen that a mere 1 percent increase can produce a huge erosion of the buyers' purchasing power. And sellers on the move understand this and reduce prices accordingly.