Let’s talk about interest rates for a while. As we have discussed before, when most people buy a home, they tend to determine how much they will spend based on the monthly payment they can afford. Two components make up your monthly payment when you buy a home: loan amount and interest rate.
A common theme in recent real estate reporting is to repeat the scare-tactic that rising interest rates will eliminate any savings that “fence-sitters” stand to gain by waiting to buy until prices fall further. It is definitely true that while falling prices drop your monthly payment, rising interest rates cause them to increase. However, if people’s willingness and ability to pay for a home is based entirely on their monthly payment, does it not stand to reason that rising interest rates will actually cause prices to fall even further?
Let’s approach this by way of example. John and Sally Smith have gone to a mortgage broker to get pre-approved. They find that they can afford a monthly payment of $2,700. At an interest rate of 6%, that will be enough to get them a loan for $450,000, the price of a median-priced house in King County (let’s assume they’re also putting zero down).
The Smith’s shop around for a while, but decide to put off purchasing right now. Interest rates go up from 6% to 7%. Now their $2,700 monthly payment can only get them a $405,000 loan. But wait, if everyone is buying homes based on their monthly payment, who is going to buy the $450,000 home? Is it more likely that home prices will be flat/increasing in this scenario, or that prices will drop as interest rates increase?
It may be instructive to look at a visual representation of what I’m talking about here. The blue line on the chart below shows the home price + interest rate combinations that give a monthly principal + interest payment of $2,700. The purple line shows what the monthly payment would be (right axis) for a fixed home price of $450,000.
For those who believe that interest rates will climb significantly while home prices stay flat or even increase: I would love for you to explain how anyone will afford homes in that scenario. At even 10% interest, the monthly payment on a $450,000 home shoots up to nearly $4,000.
I’m not saying I don’t think interest rates will go up, I’m saying that rising interest rates will only put even more downward pressure on home prices, in addition to the depreciation that’s already underway. If you have a cohesive argument that demonstrates why things will play out differently, please share.
[Update]
The best argument anyone has brought out so far basically boils down to “prices won’t go down, people will just buy smaller houses.” If that’s the case, won’t sellers of more expensive houses have fewer buyers as a result, forcing them to drop their prices?
Jump to the bottom to add your comment. ↓
141 responses so far ↓
1
Birdie Num Nums
// Jul 16, 2008 at 1:17 pm
Forgive my financial ignorance, but would not many of the fellow Smiths, who can now afford only a $405,000 home (and not the $450K ones any longer)–with the rising interest rate now at 7%–then all compete for whatever $405K homes there are out there for sale; while the Johnny Joneses of the area, who once were considering a $500K home, now bid on the $450K homes the Smiths no longer can afford; and so forth up and down the food chain?
2
The Tim
// Jul 16, 2008 at 1:23 pm
Consider that each tier you go up, there are fewer and fewer eligible buyers. So let’s say that at today’s prices there are 500 eligible buyers for the $405k home, 400 for the $450k home, and 350 for the $500k home. If everybody just moves down and considers the homes they can now afford, what happens to the sellers of the homes on the higher end?
If there were 800 people trying to sell $450k homes before, and now there are only 350 potential buyers instead of 400, some of them will have to lower their prices. The further up the “food chain” you go, the more pressure there will be on sellers to drop their prices, which in turn puts pressure on the sellers lower on the food chain.
3
vboring
// Jul 16, 2008 at 1:24 pm
this is a good visualization of why we’re screwed.
annualized CPI was reported as above 5%. this strongly encourages the Fed to increase rates. but unemployment is also too high and rising, which pushes them to decrease rates.
and housing is SOL if rates go up, as demonstrated by the Tim’s charts.
so, sure, keep your money in that CD, paying 3% nominal. aka -2% real.
or put it in the market and hope that we have a few more days like today before unemployment or bank failures or inflation fears shake things up again.
4
NoMoreWork
// Jul 16, 2008 at 1:28 pm
Birdie Num Nums,
Wouldn’t that mean everyone is lowering their budget for a house, thus driving home prices down? Your scenario sound reasonable but it all still leads to one thing: depressed home values.
Example:
@6%
20 people shopping for $450k
10 for $500k
5 for $600K
then @7% the brackets would shift lower
20 people shopping for $405k
10 for $450k
5 for $540K
etc….
The inventory (supply) would have to adjust to this new buyer pool (demand) as all 20 supposed $450k houses would have less available buyers, and so on and so on… Course this is Seattle so people probably wouldn’t lower prices. The “it’ll sell for asking, I haven’t lowered my price in 10 months, why lower it now” mentality never ceases to amaze me around here.
5
Roger
// Jul 16, 2008 at 1:29 pm
Problem is, Birdie, the number of potential buyers falls off rapidly as prices rise, and the overall pool of buyers becomes smaller, meaning fewer buyers chasing more sellers, which would cause prices to fall anyway.
If you have 100 potential buyers, there will be a percentage near the top that don’t care about interest, and a percentage at the bottom who can barely squeak into the game. Let’s say 50 of the 100 buyers are qualified to buy your home at 6% interest. If the interest rate goes up, it might be that only 40 of the 100 now qualify.
But it’s worse than that. The pool of potential buyers in the market has fallen from 100 to 80, perhaps. So not only has the pool of potential buyers for your place fallen, but the overall pool has shrunk, while inventory remains the same.
The higher the home price (to a certain point, I doubt that sellers of ultra-top-end homes are affected much), the worse the effect. When your pool of potential buyers falls from 10 in 100 to 5 in 100, your house is going to sit for a very long time.
6
NoMoreWork
// Jul 16, 2008 at 1:29 pm
Didn’t mean to Parrot you TIm, your comment wasn’t up while I was writing mine.
Great minds think alike?…. or is it, no two fools differ?
Probably the latter
7
vboring
// Jul 16, 2008 at 1:42 pm
Roger touched on an important point.
different parts of the market are sensitive to financing in different ways. different people will bring different amounts of cash to the table.
presumably, the lower the tier, the smaller the downpayment, the greater the sensitivity to interest rates.
so, higher interests rates would be great for someone with piles of cash and the desire to own a house in Renton.
8
jon
// Jul 16, 2008 at 1:50 pm
Not all houses that people buy are sitting around waiting to be purchased. Many are constructed on demand. Those will get built smaller. The existing, larger houses will continue to comp themselves to the larger new houses, and yes they will sell more slowly than before. Builders will stop build large new houses for a while because of the now excess supply at that price point. Any urgent sellers will lower their price. But after a few months, the supply over the 450K houses will gradually come down as some of the the $500K buyers who are in a hurry settle for them. So the median price will fall, but the actual price of each home will not fall as much.
Also, people will avoid buying and just wait for lower interest rates ahead, while saving up a larger down payment. That will encourage people in an emergency to sell, but others can wait also, perhaps renting it out to the very same buyers who are waiting (although I think people generally rent smaller than they buy).
All of this is because houses are priced according to the cost of replacement in the long term. Short term fluctuations in interest rates just cause people to adjust their timing.
9
jon
// Jul 16, 2008 at 1:56 pm
One more point. The buyers who pay $400K and wind up with a smaller house than they would have will trade up when interest rates go back down, or just use the extra money for other purposes.
10
TheHulk
// Jul 16, 2008 at 1:58 pm
Let us also not forget that a rising “prime rate” is the tide that lifts all boats. (Although mortgage rates don’t really track with those that well, they track better with 10+ year bond rates). If you saw a percentage point increase in your mortgage from 6 to 7, you are pretty much assured that the rate has climbed on all other kinds of loans as well (think car loans, credit cards etc.).
In todays market where we have barely seen any wage appreciation since Y2K, this would put even more pressure on the person who can barely afford a 2500 per month mortgage. Couple that with increasing energy costs (just look at the so called non-core inflation numbers published today) and you can see very well how this can run downhill pretty fast.
Tim’s charts don’t reflect this reality where even though your mortgage payment stays the same, your net debt to income ratio for every month keeps creeping up.
11
frede
// Jul 16, 2008 at 2:04 pm
right. and the ramen eaters want you to buy before that happens, because the interest hikes only benefit the banks, not the re’s.
they know that when the rates go up, buyers will be looking to spend less, so they’ll have to fly prices lower to get buyers.
so get those suckers to buy now.
it hurts sellers too, which sucks for someone really trying to move out of their home and not just dumping investments. but most houses are still overvalued.
12
Alex
// Jul 16, 2008 at 2:17 pm
Birdie Num Num:
By definition, there are not enough Joneses to take the place of all the Smiths.
Reasoning: the $450k is a very special number: it is the *median* price of all homes currently sold. Likewise the “Smiths” are very special people: they are average people who want to live in an average house.
13
Amy
// Jul 16, 2008 at 2:19 pm
So let’s take an example:
Interest rates rose from May 1 (5.75%) to 6.375% to June 16.
During that time, a house sold for 98 percent of the original listing price… so for a 450k home they could purchase it for $441k.
Your monthly payment would be $100 cheaper at 5.75 and 450k than it is at 441k and 6.375%.
Interest rates are tied closer to the 10 year treasury… which is continuing to rise… Watch it go up, up and up.
People need homes. People will always buy homes. If you need a home, there is no reason to SIT on the sidelines… you may end up losing more money.
Of course, if you are speculating, or can handle the renters next door who don’t care about their home, your home, or your privacy, then stay where you are:)
14
Sniglet
// Jul 16, 2008 at 2:24 pm
Rising rates might make it harder for people to buy homes (and hurt the market), but the flip-side isn’t exactly true. There is no reason that the downturn can’t get worse, even with low rates.
The decline so far has occured during a period of low mortgage rates, which just goes to prove that rates themselves don’t determine the direction of the market.
What good are low rates if fewer people can qualify for loans and larger down-payments are required (e.g. it is getting tough to find mortgage insurance since the insurance firms are near bankruptcy, making it difficult to buy without a large down-payment)? Job losses due to an economic contraction can also put a damper on real-estate.
All those real-estate bulls calling for low rates just might get their wish, and still find no succor. Low mortgage rates, in and of themselves, will not rejuvenate real-estate.
15
TJ_98370
// Jul 16, 2008 at 2:25 pm
Off topic, but worth attending to IMO. Mr. Bernanke covers a lot of territory in his remarks……
Bernanke Remarks On Housing Market and Credit Crunch
Video and transcript
16
Roger
// Jul 16, 2008 at 2:29 pm
Also to be considered, to build on TheHulk’s point: People in the recent past has stretched to buy all the house that they could possibly afford, artificially inflating the pool of buyers at higher price points.
That’s an easy-enough rationalization to make when the other expenses in your life seem like constants. Now, with rapidly increasing fuel and food prices, I bet folks are a lot less willing to balance on that knife edge of liquidity just to get granite and a bonus room they’ll never do anything with.
17
Roger
// Jul 16, 2008 at 2:34 pm
Amy, your post lacks coherence. How, in a deflating housing market, can you lose money by buying now? That makes no sense.
Please post some sort of data point that renters are concerned less with your privacy than owners. That has to be one of the most bizarre contentions I’ve seen yet.
18
Bits_of_Real_Panther
// Jul 16, 2008 at 2:36 pm
“Interest rates are tied closer to the 10 year treasury… which is continuing to rise… Watch it go up, up and up.” The yield on the 10 year T is likely to languish in its current range (3.5-5) for a good long while IMO. Place your bets
19
Amy
// Jul 16, 2008 at 2:49 pm
Roger,
I am not sure what part you don’t get. I laid out the way you would lose money. You would be paying $100 dollars more for the same house that depreciated in the last six months with today’s interest rates than if you would have bitten the bullet and purchased that exact same home with lower interest rates. What part of that do you not get?
Have you ever visited a rental home versus a home that has been lived in by owners? I have, and one of the reasons I would never purchase a conversion project, nor would I purchase a home that has been rented out for more than a few years. Renters have no phychological attachment to the home. They pay a rent, which psychologically means they can do whatever they want in the home without fear of retort (except for a measily security deposit). An owner must maintain the home in the fear that if things turn for the worse, they would have to sell.
There are exceptions, but I doubt there is any formal research that vindicate my points. I know I have been in hundred’s of homes, and in my brief, albeit unsophisticated research, I find homes that have been lived in are far better maintained and cared for. I also find that generally speaking, the cream of our society are not renting homes, so therefore you receive a plethora of rather not-well-off people living in a rental home. I mean no disrespect, but if you aren’t owning, it’s usually because you can’t afford to own or don’t have your act together enough to save enough money, be responsible enough to purchase a home. With the cost of real estate in Seattle, I have no doubt that it is more the former than the latter. There are other’s as well… but I won’t go into those.
20
Brad
// Jul 16, 2008 at 2:52 pm
Nice troll, Amy.
21
vboring
// Jul 16, 2008 at 2:56 pm
i agree that interest rates are likely to increase and that this will encourage house prices to fall more rapidly than they would with stable low rates.
i’m not convinced that prices will fall rapidly enough to make up for the increase in monthly payments due to increasing interest rates in the short term.
i’m also not convinced that rates as low as these will return. they are low because the system went crazy. the system is being taken to the woodshed. it may be a while before it goes so crazy again. 10% may be the new 6%, especially if the Fed decides to actually fight inflation or if one of the GSEs goes under.
it could be decades before we see 6% RE loans again.
22
masaba
// Jul 16, 2008 at 3:21 pm
Amy, just go through a smattering of old homes that people have purchased (not rented) in Seattle if you want to see the true butcher jobs on a house. Many of the do-it-yourself fixer upper types in this city who thought that they could milk some sweet equity out of a home by finishing the basement are equivalent to if not worse than the damage done by renters.
23
Lake Hills Landlord
// Jul 16, 2008 at 3:22 pm
Amy,
I can provide an equally useless counterpoint to your contention that renters are somehow less than owners. My tenants make several times what I make annually and decorate and take care of my rental better than I did when I lived there. We could trade anecdotes all day, but it doesn’t really prove anything either way.
As far as the $100 per month difference goes, I suspect the $9k drop doesn’t reflect the increase in interest rates yet. I don’t have data, but I would guess that price drops will significantly lag interest rate increases. Does anyone have historical data that backs this idea up?
24
Jonny
// Jul 16, 2008 at 3:24 pm
vboring: Doesn’t the chart convince you? if you are unconvinced that on prices will fall approximately on the curve shown, then you must believe that people are going to be willing and able to pay larger monthly payments. in this environment, with wage stagnation and increasing commodity and energy prices, how exactly do you see that happening?
25
Silver9
// Jul 16, 2008 at 3:32 pm
Great chart and a great topic for discussion.
Looking at this situation in reverse is also a good argument for how Greenspan/Bush screwed us by lowering rates so low for so long. the dotcom crash was bad but this is going to be much worse in the long run.
By dropping rates so low, people could afford more house and the house sellers responded by raising prices so that we got where we are today: run-down, poorly built homes that are selling for $500k and more. Maybe I am just old and remember $100k homes but a half-million bucks is a LOT of money and who wants to be paying for anything for 30 or 40 years?
Big changes in interest rates have a huge impact on our lives. Lower rates felt good for a while but unwinding this mess is a major hangover. Nor is it even clear how our government is going to respond to the historic problems caused by flooding the money supply.
As someone who is tired of renting, this whole situation is both personal and painful and the future is very uncertain. Bah humbug :(
26
Lake Hills Renter
// Jul 16, 2008 at 3:40 pm
Funny, but the house and yard I’m renting is as well kept (if not better) than most of my owner neighbors, I have as much privacy as they do, and my rent payments are half of their mortgage payments. And since the neighborhood is starting to decline (lots of new owners lately in the area that just don’t seem to care about the neighborhood) I can pick up and move if it gets bad enough at much less expense. But then since I’m renting I’m apparently be not-well-off, don’t have my act together, and aren’t responsible. Otherwise I’d be stuck in my house too.
Aren’t stereptypes fun? Amy did renters, so now who’s going to do owners?
27
Silver9
// Jul 16, 2008 at 3:44 pm
To address Amy’s points about the “creme” of society and deadbeat renters.
Owning a house is a certain hurdle so I would imagine that the least capable of our society are mostly renters.
However, in my experience it is the landlords not the renters who have no personal attachment to the homes. For them it is an investment and any money they spend on the house is money out of their pockets.
In the property we are currently renting, I have told our landlord about a huge list of things that are broken or worn out; I have even offered to fix them but he refuses to spend money on anything that he is not legally required to do. After all, why should he spend money on “my” house?
Renting makes total financial sense right now but it is very hard to find a landlord that is a pleasure to rent from.
28
vboring
// Jul 16, 2008 at 3:52 pm
Jonny:
1) some people bring cash to the table. big wads of it. they will care less about interest rates
2) in the past when interest rates get high, people get creative with RE financing. there was a time when owner financing wasn’t uncommon in the used house market. sort of like taking over someone else’s car loan.
3) the gov’t doesn’t want housing to be unaffordable. they may engage in all sorts of silly programs and subsidies.
4) reality in general: CalculatedRisk did an analysis of the strength of correlation between house prices and interest rates. i gotta run catch a bus. maybe someone else can go find a link for it. if i remember, they are correlated, but certainly not 100%.
29
cm
// Jul 16, 2008 at 3:58 pm
If rates go up and the buyer could afford $2700 at 6% on a 30 year fixed rate mortgage and prices do not drop enough to offset the new 7% rate, they will look at other financing options (ARMS and Interest Only loans) before buying smaller house. This will prolong the need for sellers to lower the price.
30
NotAnOwner
// Jul 16, 2008 at 4:13 pm
I can’t believe no one has mentioned inflation yet in this discussion… well, you could think of the shift towards smaller homes as a form of inflation.
Anyway, here goes: Interest rates are a measure of predicted inflation. Basically, they are the hedge the entity giving you 450,000 now is using to protect their investment, i.e. they want the 450k they loaned you to still be worth at least 450k when they get paid back.
Now, if inflation is also pumping up wages (which happened the last couple times we had major inflation in this country) then 450k today isn’t 450k tomorrow, it is a lot more. So, in this case, increasing interest rates don’t affect affordability all that much because the Smiths will be pulling in more money.
On the other hand, if there isn’t wage inflation (which is what we are experiencing now) rising interest rates should indeed curb demand. The purchasing power of the Smiths is being corroded over time, making that 450k home more and more of a stretch.
Basically, rising interest rates can impact demand, but don’t have to. Given that we aren’t likely to experience crazy wage inflation any time soon, I would certainly expect rising interest rates to decrease demand (and thereby leading to reduced prices).
31
Joel
// Jul 16, 2008 at 4:18 pm
Allow me to preempt RAL and magnolia by saying:
lol you guys crack me up. itll be even harder for you renters with no money to buy when interest rates go up lol. your to stupid to understand that just because you can’t afford it doesn’t mean everybody cant afford it. theres always someone richer than you lol.
32
mike2
// Jul 16, 2008 at 4:19 pm
“prices won’t go down, people will just buy smaller houses.”
Or they’ll buy foreclosures. Check out southern california. 40% of homes sold are foreclosures, and payments are down 35% YOY.
Interest rates doen’t even appear to be in this equation.
33
been there
// Jul 16, 2008 at 4:20 pm
If interest rates shoot up, that means inflation is up. Wages will go up sooner than later. I would love to pay my morthgage up with few monthly salaries. That’s what my parents did in the early 90s in Eastern Europe. The wage increase might not be as extreme, but with inflation wages will go up.
34
Sniglet
// Jul 16, 2008 at 4:35 pm
Is there any correlation between interest rates and house price appreciation/depreciation? It would be very interesting to chart housing prices against mortgage rates. I suspect that there is no direct correlation (i.e. that there are times when rates are falling and times when prices are falling as rates are increasing) but it would be great to confirm that.
35
NoMoreWork
// Jul 16, 2008 at 4:38 pm
Interest rates might rise but it will take some time to get to 10%. During this time, housing prices will fall and renters will squirrel away as much money as they can (taking advantage of rising savings rates). They can do this because >50% of their income isn’t going to housing payments.
So when the time comes, renters will have a large $um as a downpayment that will go a lot farther when applied to the depressed housing prices, thus lowering monthly payments. The current interest rate “savings” on the monthly payments, because of a couple % points, will be negligible compared to the equity they will build.
36
The Tim
// Jul 16, 2008 at 4:39 pm
Sniglet, I agree, there likely is not a direct correlation, and I wasn’t trying to say that there would be with that chart. I was just trying to show rising rates will put downward pressure on home prices. In the past things like suicide loans and insane financing have come in to play to relieve that pressure, though I doubt such nonsense will work again in the near future should rates indeed rise.
37
Joel
// Jul 16, 2008 at 4:41 pm
38
NoMoreWork
// Jul 16, 2008 at 4:44 pm
Sniglet,
I’m not sure there’s ever been a time in America where housing values have impacted the overall health of the nation like present day.
The rates were lowered as a reaction to the melt down in the credit market and collapsing bubbles around the nation. As a result of that, the rates will rise as we try to curb inflation. I believe an impact of this will be further declining (in Seattle and some other markets) or flatlining (elsewhere) home values.
39
mike2
// Jul 16, 2008 at 4:45 pm
Have you ever visited a rental home versus a home that has been lived in by owners? I have, and one of the reasons I would never purchase a conversion project, nor would I purchase a home that has been rented out for more than a few years. Renters have no phychological attachment to the home. They pay a rent, which psychologically means they can do whatever they want in the home without fear of retort
Interesting. I’ve been in each of the recent resales on my street and the place I rent it nicer. Granted, the owner did a full remodel right before we moved in, but we’d have to trash the place to bring it down to the standards of the other homes - not to mention rip out all of the granite, wood floors, carpet and new appliances.
In case you’re wondering, the last 4 nearby sales were all owner occupied before hand. They just happened to be slobs with poor taste that bought when the neighborhood was cheaper.
40
Bits_of_Real_Panther
// Jul 16, 2008 at 4:47 pm
I can’t find many good articles relating rates and prices. Changes in median home size also confounds the issue. Here’s an interesting read from two years ago
http://www.uli.org/AM/Template.cfm?Section=Search&template=/CM/HTMLDisplay.cfm&ContentID=65390
41
Bella
// Jul 16, 2008 at 5:05 pm
Um, as someone who started watching the market at the beginning of this year for a reason that I simply can’t remember, I really have to say that prices HAVE dropped.
A year ago, I was almost starting to believe that prices were going to stay high forever and that I would never be able to buy a house. At the beginning of this year, I started to notice some more reasonable prices for houses in my area (Ballard) that I would consider buying. A couple of months ago, I spotted the first house that made me think “If I was ready to buy, I’d make an offer”. This was after watching houses in what I considered a reasonable price range (up to about $375k) sit for months and then finally drop.
We started going out to look at houses, and honestly, most of them SUCK. But at least houses existed in a somewhat more affordable range, where they didn’t before.
About a month and a half ago, we found a house that we liked, even though it was still too small. It didn’t work out, and now, we’re pretty happy about that because we’ve found another house that is nearly twice as big, for the same price.
No, I’m not watching the ENTIRE market, I am only watching it for myself - a certain (low by most standards today) price range, and a certain neighborhood, but what I’ve experienced is a real life experience and it has to mean something.
42
Bits_of_Real_Panther
// Jul 16, 2008 at 5:14 pm
Shiller wrote a paper on the topic of rates vs. prices last year
http://cowles.econ.yale.edu/P/cd/d16a/d1632.pdf
43
Bella
// Jul 16, 2008 at 5:14 pm
And now that I’ve read all the comments and not just the update to the original post…
It’s true what was said up there somewhere about some of the DIY remodels owners have done to their homes being worse than how renters trash them. The houses that I mentioned that SUCK? Those are the ones I’m talking about.
We have seen a number of what our agent called “add-a-shacks” which made me think of “Silence of the Lambs”. We saw one house in which the owners had decided to “add a basement”, by which I mean went down there with a shovel and excavated a gaping pit under the house over 20 years. That house was ready to cave in at any time.
Even the last house that I rented before the one I hope to move from soon, looked really nice on the surface, but after having lived there for a while, I realized that the owners had done the work themselves, and while they didn’t do anything utterly tragic, it certainly wasn’t a high quality remodel that would make their house worth hundreds of thousands more than what they ended up selling it for.
44
Ira Sacharoff
// Jul 16, 2008 at 5:20 pm
“prices won’t go down, people will just buy smaller houses.”
If that’s true, neighborhoods like Skyway, with their post World War 2 crackerboxes, should be highly sought after.
45
Alex
// Jul 16, 2008 at 5:29 pm
Wait a minute!
The King Count Median sale price rose from May to June. And interest also rose in the same period.
Doesn’t that mean that the “Smiths” in our area decided to swallow the extra $100 a month, and still buy a house that’s worth $450k?
46
gill
// Jul 16, 2008 at 5:33 pm
tim –
i think there’s a hole in your arguement in using the ‘zero down’ contingent. fact is that while that happened frequently in the recent past most people plan on having at least 10% to 20% saved up for a down payment.
47
Garth
// Jul 16, 2008 at 6:29 pm
I think gas prices with their six foot signs on every corner and food prices with a trip every week are having a far greater impact on people’s behavior than I have ever seen with interest rates.
Even in the scenario that Tim laid out above , the person buying with 100% financing is not getting 6% for the whole amount, they will either have to buy mortgage insurance (.5 - .75%) or 20-25% of the sale price would be in a heloc with a couple point higher rate. 100% is not really an option anymore either, a low down payment now is 3-5%. It has been quite a while since 20% was a normal down payment for buyers who were not selling another home.
48
Joel
// Jul 16, 2008 at 7:04 pm
True. 3% is probably accurate for the current market given how big of a role FHA has taken on lately.
49
economist
// Jul 16, 2008 at 7:52 pm
Now, if inflation is also pumping up wages (which happened the last couple times we had major inflation in this country)
Back in those days the US had things called “unions” and “manufacturing”, and the Chinese were running around waving Little Red Books rather than making all the stuff the US doesn’t make anymore.
Wages are not going to keep up with inflation, and stagnant wages with rising consumer prices means lower house prices.
50
Ron
// Jul 16, 2008 at 7:55 pm
Hello.. just checking to see if this works first before I put in my comment..
51
Ron
// Jul 16, 2008 at 8:06 pm
Here is my Comment:
I dont post here very often- at least a year or longer?
anyways what I dont like about this Website is the Lack of depth… im a implod-o-meter and Economist fan..
Anyways I think you guys are all forgetting the real Story with Higher interest Rates its not Only going to Place more pressure on the Prices Which will go lower… The Real Story is the NEGITIVE Equity Positions that Places on everyone that Signed A Rental Ageement with there Banker.. See a great deal of people Think there Owners and in the process of loosing Whats Imaginary Equity, they will feel like renters- if not already there.
Whats caused the Deflation to get much Worse in Places like California IS JUST THAT~!! … NEGITIVE EQUITY..
I Have had several people approach me about this same thing.. WORRIED ABOUT THERE “NEGITIVE POSITIONS IN REAL ESTATE”.
The Truth is Many People are Feeling like renters in Mortgages that steal all there Potential Savings…. now to top it off the Utilities and Gasoline is Just Icing on the Cake.
52
TJ_98370
// Jul 16, 2008 at 8:16 pm
Interesting thread. Two comments:
1) I can find no article or study that shows a direct correlation between mortgage interest rates and real estate market values. If someone else can, please share. Inquiring minds want to know.
2) Considering the fact that a solid, agreed upon definition of “inflation” does not seem to exist, assuming future effects of “inflation” appear presumptuous. Can we expect overall wage increases in the near future? Are the recent increases of prices of oil and food due to increased global demand, currency exchange rates, speculation, increased money supply, or all / none of the above? Also, if we are experiencing inflation, why are real estate values decreasing?
.
.
53
Ron
// Jul 16, 2008 at 8:18 pm
Here is another Point:
See I much rather Pay a Higher Interest Rate… Especially IF THE PRICE IS LOWER….
Why? its Called the Mortgage INTEREST DEDUCTION..
IF everything is equal in pricing- that is Ending Price, hard to explain in one couple of lines, maybe? - maybe one of you here could get to the point better than I can, I spend 30+ hours a week studying everything from taxes to stock, currencies, real estate- anything dealing with money, Im one of the guys that been shorting the likes of Cfc, C, Wm etc.
“I Get roughly a 20% mortgage interest deduction on my taxes- mortgage interest… so prices do down with higher interest rates those interest rates create greater tax savings in the end.
Interest rate goes up Price Goes Down… at least the Interest is a Deductable..
Thing is there is many ways you dont have to deal with the bank- Wrap arround Mortgage, Lease Puchase agreement etc.
Put it this way there is many ways to control property without the bank standing in the way… I wont go any further here on this web-site.
54
Ron
// Jul 16, 2008 at 8:25 pm
The End point is Dont let Interest Rates Create Fear…
There is always and upside created out of every Downside, just need to be creative in your approach and way at looking at it.
When I said you didnt need to Go to the Bank, You really dont.. ive Controlled a Total of 8 different Houses without the Bank ever getting Involved.
The thing is the True Real estate professional investors NEVER SAID INVEST IN NEGITIVE CASH FLOW PROPERTIES.. Meaning the True value is what the property can Rent for… that is Real Estates P/E= Price to Earnings… the Problem is that whats happened is much like what happened in the Dot Com crash- companies with Negitive Cash Flow. People gotten involved with Negitive Cash flow properties that they thought were investments.
55
Ron
// Jul 16, 2008 at 8:34 pm
TJ_98370 -
really its comes down to affordability in the end.. … then again Now It comes down to also getting someone to actually let you get that loan.
TJ_98370 - inflation doesnt mean everything goes up in Value.. put it this way at the same time everything you purchase from Day to Day to live goes up..
At the same time given the Circumstances in the Credit Markets everything large you need to Buy by Borrowing goes down in Value… lack of credit creates Deflation in everything purchased with credit.
56
Jonny
// Jul 16, 2008 at 8:36 pm
Ron,
Are you sittin’ at home smokin’ a bowl, or somthin’?
57
Ron
// Jul 16, 2008 at 8:42 pm
Hopefully that clears your Questions on Inflation which is nearly everthing you purchase from day to day….
Deflation with large ticket items you pay with Credit..
Im out of here be back in another Year or So…. dont have the time to post here- I like to check back on this site from time to time to get a Pulse.
58
Ron
// Jul 16, 2008 at 8:49 pm
Figures I would get a comment like that: Are you sittin’ at home smokin’ a bowl, or somthin’?
My friends tell me Im over most Peoples heads when it comes to Investing. Wish I could explain it better. Its really a art to explain and it takes so much time and depth to really go into detail, A lot of times I Assume someone will understand some of the Limbo.. or terms I would assume your scratching your head and saying what your talking about? hang out with me about 100 hours and you will start to understand. Put it this way I had a renter that took 2 years to understand me.. he questioned me for about a year now “He just listens..
its only because this is what I do Invest, because its what I love to do.. sorry if you think Im Smoking a Bowl…hahahaha.. actually might not be a bad idea.
take care, Ron..
59
TJ_98370
// Jul 16, 2008 at 8:51 pm
Ron,
Thanx for the response. My point about the term “inflation” as it is used in the MSM is that it is almost meaningless. I read the newspaper headlines “Inflation Reaches New Heights” (AP article, sorry can’t find a link) and the article references gas and food “wholesale” costs increasing by 9.2 percent in the last 12 months. So, is that a “price adjustment” for that segment of the overall economy or is it “inflation”.
Maybe I’m just being too obsessive about terms.
.
60
mikal
// Jul 16, 2008 at 8:54 pm
Interest rate rising will greatly affect the higher priced homes. The houses priced up to $500,000 will not be as much as people will have to move down on what they can afford. It will come down to who can get a loan. The bubble is being deflated by that more than anything.
61
rose-colored-coolaid
// Jul 16, 2008 at 8:58 pm
I missed the bus here, but there seems to have been a bit of an argument about how much of a leading/trailing indicator interest rates are.
One of the first things to do when buying is go find a lender who you can get a rate quote from. My understanding is that if you purchase in a reasonable time (say 90 days), you get the rate you had quoted to you, even if rates in general have increased since then.
If so, price declines would trail rate increases by no less than 3 months.
62
Ron
// Jul 16, 2008 at 9:03 pm
I would say were living in a World of Inflation and Deflation…
Myself I find myself reading the same information over and over again- I’ve probably have read the same article already, then again I read the same information over and over again like most people.
just because nearly everything is going up.. doesnt mean everything is going up- supply and demand always plays a function in the markets- if they built to many houses and put up to many apartment buildings then the prices they can charge will reflect down… only thing that can be done is fix the credit markets and build less houses and maybe less apartments?- im also looking at the Possibility that all that inventory of Apartments to condos are soon going to find there place back in the Rental market soon.
Beleive me there is a Lot of Inventory coming back in the rental Pool in the Next 12 months… Riverstone, Champaine etc. those will be serving as rental apartments in near future, “Probably…
63
Ron
// Jul 16, 2008 at 9:10 pm
here is Excellent person that has Video Feeds and is professional in the mortgage industry- he is easy to understand and very informative.
Mrmortgage
http://mrmortgage.typepad.com./
64
TJ_98370
// Jul 16, 2008 at 9:23 pm
Mikal said: Interest rate rising will greatly affect the higher priced homes….
.
I would agree except for those that can pay cash. I actually know some people who retired, sold their home in LA a year and a half ago and bought top-priced lake-front property in Idaho (Lake Ponderay) for half of what they sold their LA home for. These type people couldn’t care less about mortgage rates. There are alot fewer California equity vultures these days, but I submit there are still people who can pay cash for real eatate and those type buyers are over-represented in the upper segments of the real estate market, wherever that may be.
.
65
Scotsman
// Jul 16, 2008 at 9:27 pm
Keep reading, Ron. You sound confused to me. Try taking on one concept at a time, and work into the inter-relationships…
The home I rent has dropped $80,000, or $12,000/month, since the first of this year. That trumps any consideration of interest rates, tax deductions, or budget constraints. And while the rate of decline has slowed a bit most recently, I still think we’re only getting started.
But hey, oil has dropped to a very reasonable $134/B, GM’s stock has shot back up, and the government has assured us (again) that everything is OK. This must be the bottom! /sarc off
66
economist
// Jul 16, 2008 at 9:40 pm
Also, if we are experiencing inflation, why are real estate values decreasing?
Because asset prices are often negatively correlated to consumer prices. It’s happened before - there was a severe bear market in stocks in the 70’s, and house prices rose only because wages were outpacing consumer prices.
It’s meaningless to talk as though “inflation” means a single metric. Monetary inflation, consumer price inflation, asset inflation, and wage inflation, are all different things and can and do move in different directions, although they do interact with each other in complex ways.
The person on the street uses “inflation” to talk about consumer price inflation, although sometimes he throws in a bit of asset (house price) inflation as well. CPI measures (or is supposed to measure) consumer price inflation only, so it should not and does not include asset prices such as house prices.
The difference between assets and consumables, BTW, is that nobody ever has to buy assets. Assets are investments that provide a future return.
67
jon
// Jul 16, 2008 at 9:45 pm
“If that’s the case, won’t sellers of more expensive houses have fewer buyers as a result, forcing them to drop their prices?”
There are a lot of unspecified conditions in this hypothetical situation, but higher interest rates are usually caused by high inflation. High end home-buyers are the owners of assets that produce income that goes up with inflation. They will be looking for inflation and tax hedges, and real-estate is an excellent candidate. So I don’t think the assumption that there will be fewer buyers at the top is correct. They will be willing to pay high prices in order to get protection in case inflation gets worse.
68
Ron
// Jul 16, 2008 at 9:52 pm
Keep reading, Ron. You sound confused to me.- Confused about what?
I thought the Point of the Argument here was Interest Rates going up and how it would negitively affect the person that Didnt jump into getting on the Housing Train today..
I understand very Welly on Houseing pricing going down as we speak without that happening.. there are so many factors at this moment that only speak to much happening for a downside effect- in fact I Really cant, even if I tryed to come up with any Upsides to jumping into the Housing mix… What Upside? please anyone lets here the upside “Financially speaking?— besides the renter throwing there money away– im not renting, however Im in the process of trying to become a Renter…. hell “I want to rent right now…
The End- nothing Definitly Follows, Not Even if you try……… see you next year, after I become a renter…
69
Ron
// Jul 16, 2008 at 9:55 pm
Ive just finished 2 bottles of wine.. sorry about my spelling going Downhill in last couple of Posts.. Out of Here…
70
TJ_98370
// Jul 16, 2008 at 10:00 pm
economist said:
…It’s meaningless to talk as though “inflation” means a single metric….
Well said. I’ve come to the same comclusion, yet the MSM often uses the term “inflation” as a single metric / overall concept. I think generalizing the term is misleading and a disservice for mainstream readers with no background in economics.
.
71
Scotsman
// Jul 16, 2008 at 10:10 pm
It will take more than two bottles of wine to dull the pain of equity losses already on the books, and those yet to come. A friend has already lost the equivalent of everything he’ll make in the next three years, and has yet to bite the bullet and bail. By recognizing that renting might be a wise move in this particular market you’re well ahead of the masses who have yet to see the reality of what’s coming.
72
TJ_98370
// Jul 16, 2008 at 10:18 pm
Ron, my lady suggested I post this for you. Sweet dreams!!!
.
Bottle of wine, fruit of the vine, when you gonna let me get sober. Let me alone. Let me go home. Let me back and start over.
Well, I’ve rambled around this dirty old town singing for nickels and dimes.
Times getting’ rough. I can’t get enough to buy me a little bottle of wine.
[Chorus]
Well, little hotel, older than hell, cold as the dark in the mine.
Light so dim, I had to grin, I got me a little bottle of wine.
[Chorus]
Well, the preacher will preach and the teacher will teach. The miner will dig in the mine.
I ride the rods, trusting in God, huggin’ my little bottle of wine.
[Chorus]
Well, pain in my head, bugs in my bed, pants so old that they shine.
Out on the street, I tell the people I meet to buy me a little bottle of wine.
[Chorus]
Bottle of wine, fruit of the vine, when you gonna let me get sober.
73
TJ_98370
// Jul 16, 2008 at 10:25 pm
With that last post, I’m thinking I’ve done enough damage to Tim’s blog for one day. All done in fun, okay!!!!
74
mikal
// Jul 16, 2008 at 10:42 pm
scotsman, why bail. The fees don’t make it worth it. Same areas haven’t lost any value. Even those that have haven’t lost enough to scare a person to sell unless they bought after 2005. And then they are screwed anyway. I’m dying in this house so I don’t care about any paper losses. Then again, it is going to be alot of drops for me to be underwater in any of my houses. Any gains I have have also been on paper. Your another one that must be a blast at a party. THANK GOD FOOTBALL IS ABOUT TO START.
75
On Topic This Time
// Jul 16, 2008 at 10:50 pm
Personally, I would rather buy at high interest and low prices than low interest and high prices.
As a potential first-time-buyer, I think about it this way:
1) If I buy when prices are low because of high interest, then if/when I need to move, the house has more value and I don’t take a loss. I’m not trapped.
2) If most people buy on what they can afford “monthly”, I win because they don’t spread their tax savings evenly throughout the year into the home (We can afford that big screen TV now!), which pushes down costs for financially prudent people who already bought under their limits
3) If I buy when interest is high and then rates drop, I can refinance into better payments. You can negotiate a new loan, you can’t negotiate a new purchase price. I might take a hit in the semi-short run, but I can fix it within a few years. It’s like an ARM, only good.
I can (barely) afford to buy in my neighborhood, but I think it’s foolish to do so right now unless we begin to see severe inflation (capable of effectively wiping out any debts) and the fed takes no action to suppress it.
The question at this point is “Which bullet will the fed bite?”… They can’t ignore inflation for much longer.
76
mikal
// Jul 16, 2008 at 10:56 pm
Agreed, but what many of you aren’t understanding is that there are ALOT of people that can afford houses up to $500,000 even if interest rates rise. It won’t help any of you. It is getting a loan that will help you or hurt you. It is harder to get a loan. Even if you have good credit.
77
Herman
// Jul 17, 2008 at 1:09 am
I think Tim’s scenario assumes a high degree of elasticity.
Elasticity = how easy it is for the market to shift to the “theoretically perfect” supply/demand and price point.
In practice I think that there are a number of factors that impact price elasticity for homes. For example, your seller who is “forced” to drop his price to $405,000 may not be able to do so because it creates a short sale, or he may mentally feel like he doesn’t want to sell that low. The home is therefore never listed for sale, which contracts supply.
Of course, in an environment where job losses are happening, people become FORCED to sell. That can be a trigger for elasticity.
Given the inelasticity, it just takes a while for the higher interest rates to have their effect. And so the price drops you want will lag behind the rising interest rates.
That’s my guess anyway. To summarize:
“In a period of RISING interest rates, homes will be less affordable - more costly to obtain - than a period after interest rates have been STABLE for some time or are FALLING.”
78
economist
// Jul 17, 2008 at 1:14 am
High end home-buyers are the owners of assets that produce income that goes up with inflation
Really now? How’s the stock market doing?
As I said, consumer price inflation is often accompanied by asset price deflation.
79
Buceri
// Jul 17, 2008 at 4:48 am
- Median income in the US went down 1% YOY for June 08.
The stat got lost in the shuffle of news during the past 48 hrs (Bernanke’s “the economy faces numerous difficulties”, Polston’s “give a blank check; I won’t use it; but the blank check will give people confidence”; and our president’s: “your money is safe….if you have less than $100K. HAHA”.)
The Hulk @10. Agree…..People are getting hit from everywhere; it’s not a case of just interest rates vs. home prices. Throw in the equation the increase of food, gas, and most importantly: “will I have a job next week?”
Joel - thank you for representing RAL and Magnolia. The discussion was getting too coherent.
80
NotaBull
// Jul 17, 2008 at 7:55 am
RCC said: “My understanding is that if you purchase in a reasonable time (say 90 days), you get the rate you had quoted to you, even if rates in general have increased since then.”
The quoted rate will just be the rate at the time, or perhaps a little higher if the lender wants to ensure that they qualify you for an amount of money with a little room for rates to rise in the near future.
You only get to keep a rate if you “lock” with the lender, which is often a 30 day lock. You can pay for longer periods, but it can cost thousands of dollars and/or an increase in the rate you pay. So you’re almost always better off waiting to figure out the property you’ll buy, then working with your lender to lock the loan some time in the next few weeks prior to closing. There’s usually a window of a few weeks during escrow that you can watch the rates and make the decision of when to lock.
81
jcricket
// Jul 17, 2008 at 8:24 am
Isn’t that pretty much the problem with all the armchair analysis going on here? Everyone acts as if their “assumptions” are the 100% dead-on right “facts” in a massively complex national and global economy - which always makes me laugh. First off, they’re often incorrect from a simple study of historical precedents (as economist and others have pointed out). Secondly, as Malthus and other doomsayers of the past have learned, you are most likely failing to account for “paradigm shifts” will occur in the future rendering your assumptions/constraints incorrect. None of this means RE will go up forever, or a particular housing market is “balanced” or that it’s a good time to invest all your money in eBay - just that doomsday predictions that have 100% certainty tacked to them are almost always wrong in any long-term analysis.
Don’t get me wrong, when Tim sticks to the basics, I appreciate the insight he is providing. Someone needs to counter the emotion-based, biased cheerleading that goes on in the RE-driven press. However, once I start reading about 1:1 drops in prices based on rising interest rates, I know we’ve left the realm of reality and entered speculation-ville once again.
Fundamentally, the perma-bears are no better than the RE cheerleaders in that they are letting subjective validation and confirmation bias cloud their judgment.
Historically, when judging the accuracy of people who continually predict the downfall of the American economy (said perma-bears), most have been trounced by the bulls. The perma-bears are often right for a year or three, but then stick to the same attitude while the market recovers, and give back all the gains they’ve made.
Reminds me an old joke I heard when I was a physics major in college: “The difference between theory and practice, is that in theory there is no difference”
82
rafael
// Jul 17, 2008 at 9:20 am
This is simple economics where interest reates, income, inflation, new credit standards all play a role in house valuation. It is astonishing how many real estate agents don’t have a grasp on reality and basic economics.
83
Civil Servant
// Jul 17, 2008 at 9:36 am
Mikal @ 75: You say “what many of you aren’t understanding is that there are ALOT of people that can afford houses up to $500,000 even if interest rates rise.” Totally agree, and I suspect that many who post here are in that number. But I think that a dawning distrust in real-estate as a foolproof investment and general economic uncertainty especially w/r/t inflation is going to change significantly would-be buyers’ attitudes and behaviors. If those who “can” afford up to $500K make decisions that are strictly consistent with being able to afford at $400K, they effectively move themselves into the latter category. Factors like this play into the market as well.
84
Alex
// Jul 17, 2008 at 11:01 am
I would still like to see someone address this comment. Facts from May to June in King county contradict the article’s theory.
——————————————–
The King Count Median sale price rose from May to June. And interest also rose in the same period.
Doesn’t that mean that the “Smiths” in our area decided to swallow the extra $100 a month, and still buy a house that’s worth $450k
——————————————-
85
jon
// Jul 17, 2008 at 11:03 am
“Really now? How’s the stock market doing? ”
When inflation sets in stock prices go down, and yet the income will go up with inflation. The reason that the rising income does not cause a rise in the stock price is because the discount rate applied to the future income is very high also when there is inflation.
86
Joel
// Jul 17, 2008 at 11:06 am
As The Tim said in comment #2: There may be a lot but if it is fewer than if rates didn’t rise then it will cause downward pressure. Are you going to argue that no matter how much the monthly payment is there will always be the same amount of people that can afford it?
87
mark
// Jul 17, 2008 at 11:29 am
“there are ALOT of people that can afford houses up to $500,000 even if interest rates rise. It won’t help any of you.”
Those were the people that could afford houses in the 700k - 800k range at a lower rate. It’s called a falling standard of living.
88
mark
// Jul 17, 2008 at 11:43 am
How about move up buyers. Lots of talk about people buying a house and staying forever. That isn’t the usual scenario. Most people buy and sell several times in their lives.
Take someone who was lucky enough to buy a house for 250k at 6%. They’ve been in the home several years and would like to move up. Lets assume that their current house is now worth 500k. Lets also assume that interest rates are now 10%.
Original mortgage:
250K @ 6% = $1498 per month payment. P&I only.
The house is sold and they now have 250k to put down on a new house.
They buy a new house for 600k. 600k - 250k = 350k for the new mortgage.
350K @ 10% = $3071 per month payment. P&I only.
Their payment has more than doubled and they’ve barely moved up.
Move them up to a 750k house with a mortgage of 500k at 10% interst and it gets worse.
500k @ 10% = $4387 payment per month. P&I only.
When interest rates rise people have a tendancy to stay in their old homes longer.
89
deejayoh
// Jul 17, 2008 at 11:44 am
Barry Ritholz (of The Big Picture) on To the Point on NPR this morning, giving a good rundown of the banking crisis.
worth listening