Tradeoff between higher interest rates and home prices

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Submitted by werewolf34 on February 17, 2010 - 12:03pm

Can somebody talk me through how I should analyze the effects of higher interests on home prices?

I know higher rates mean lower home prices (generally) b/c people think monthly payments when buying a home.

More specifically, I've been told that a 1% rate increase lowers a home price (SFR) about $100K as a rule of thumb. Does this rule hold for SD?

What about condos?

Submitted by XBoxBoy on February 17, 2010 - 12:54pm.

werewolf34 wrote:
More specifically, I've been told that a 1% rate increase lowers a home price (SFR) about $100K as a rule of thumb. Does this rule hold for SD?

I don't think this is true anywhere. The amount of discount due to a 1% rate increase would be dependent on the price of the home. So, no set dollar amount would be valid. (It would be true if we were discussing a very specific price range)

If you would like to see what a 1% rate increase will do to home prices, you could play with a mortgage calculator. Pick a monthly payment and a down payment and vary the interest rate.

But, keep in mind that this experiment is not the complete picture. Yes, prices of homes vary with interest rates, but they also vary with people's attitudes. The housing bubble occurred mostly when interest rates were higher than they currently are. Rates have dropped as house prices have dropped, so clearly there is more at play here than just interest rates.

Submitted by davelj on February 17, 2010 - 1:09pm.

werewolf34 wrote:

I know higher rates mean lower home prices (generally) b/c people think monthly payments when buying a home.

This makes sense intuitively, but is not borne out by historical experience. For example, housing prices increased dramatically during the 70s and early-80s even though rates were increasing, because rents were tracking (high) inflation. Folks bought as a hedge against future inflation despite the high interest rates.

That may or may not happen this time around. It's too early to tell. I think higher interest rates will hurt the housing "recovery" for a while... but longer term it's hard to say.

Submitted by DataAgent on February 17, 2010 - 1:22pm.

"Can somebody talk me through how I should analyze the effects of higher interests on home prices?"

Unlike Treasury Bonds, there is no direct relationship between home prices and interest rates. Home prices could actually rise as interest rates rise. This scenario is not only possible, it actually happened several times in the past.

Submitted by jeeman on February 18, 2010 - 12:15am.

Right now, home prices are falling as interest rates fall...there is a relationship with interest rates in terms of affordability, but only because of affordability.

If there is 10% inflation and mortgages are 11-12%, home prices could go up as people let go of their dollar to buy hard assets. It's just so unpredictable.

jeeman

Submitted by CA renter on February 18, 2010 - 4:07am.

davelj wrote:
werewolf34 wrote:

I know higher rates mean lower home prices (generally) b/c people think monthly payments when buying a home.

This makes sense intuitively, but is not borne out by historical experience. For example, housing prices increased dramatically during the 70s and early-80s even though rates were increasing, because rents were tracking (high) inflation. Folks bought as a hedge against future inflation despite the high interest rates.

That may or may not happen this time around. It's too early to tell. I think higher interest rates will hurt the housing "recovery" for a while... but longer term it's hard to say.

I think this has a lot to do with the fact that Baby Boomers were in their peak buying years during this time. IMHO, this population buldge is responsible for a lot of market movement over the decades; and we just might see some more of the effects if/when they need to start selling assets in order to sustain themselves in retirement.

BTW, for anyone who doubts the effects interest rates have on housing prices, consider for a moment why the Federal Reserve has been buying MBSs and Treasuries hand-over-fist this past year. What do you think would happen to the housing market if rates were allowed to go to 7-10% tomorrow?

IMHO, interest rates actually affect the real estate market in two different ways:

1. They reduce the costs for buyers at a particular price point. (which eventually drives prices up, so buyers don't see more "affordable" housing after all)

2. In the current environment, the low rates are behind the surge of cash investments we're seeing in the RE market (IMHO). Investors are trying to escape the pain of being in low-rate bonds and debt instruments. In today's market, they can buy houses for cash, and make a greater return on rentals than they can in in the debt/bond markets. Also, cash investors are worried about inflation and the future of the dollar. This is forcing lots of money into housing at this point in time.

When rates are kept low, it forces more conservative fixed-income investors into riskier assets. This is why I believe the credit bubble grew exponentially when rates were being held so low after 2001, and why we saw the rapid growth of the mortgage-related "innovations" during this time. Low rates and easy money (malinvestment, IMHO) are very closely related.

The Fed/govt are squeezing people out of their cash positions because they are trying to reinflate asset prices (including houses). Who knows what the long-term implications of this will be, but I think it will get ugly (and this is why we are now in cash).

Submitted by DWCAP on February 18, 2010 - 1:59pm.

Somewhere on here is a thread where we discussed a measure kinda like what you are looking for. I think it was originally posted on Yahoo, but i could be mistaken.

Anyways, I used SD's level (with a 70k median income) and todays rates (~5%) that median prices should pivot right around 310k, give or take. Each adjustment to the rate of .25% gave us an 8k swing in the 'expected' median. So a 1% increase from 5% to 6% in rates would give us a ~30k decrease in purchasing power, leading to a 'expected' 280k median. Most certainly not 210k. No one challenged the math, so either it isnt too far off or I am the 'special' kid, dont really know it, and everyone is just being nice to me.(certainly a possibilty)

This is no where near perfect math. RE prices are effected by SOOOO much more than just interest rates that focus on one or two factors can, and has, led many astray. Just because people cant afford it doesnt mean they dont want it, and doesnt mean they wont find a way to get it. (liar loans anyone?)

But if you are looking for a guide post of, 'what will interest rates do to housing prices?' I would start there.

(ill let you do the search for it, I dont feel like digging for it)

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