Will rising interest rates lead to further downward pressure on home prices?

I know that interest rates are being kept artificially low but its inevitable that they will increase at some point.  I have asked this question on another site and have gotten different answers which has personally confused me further.  Anybody here have any thoughts on the subject?
  • December 12 2010 - Prospect
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Answers (16)

Profile picture for 800askmark
Many great contributions!   Regardless of interest rates, real estate values are dictated by location & condition.  Interest rates will rise gradually but will remain at record low levels for a few years.  I have found many buyer's are making quicker decisions to purchase with rising interest rates. This will continue into 2011.  
  • December 17 2010
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Profile picture for the_country_hick
Steve, in that article (Roth on Real Estate December 29, 2009, 2:05PM EST ) <A year old article that proved wrong in many ways>it says "Housing prices have dropped an enormous amount and have seemingly stabilized."

House prices have fallen in the past year nationwide. The article was about 1 year old. House prices have not stabilized now. They were not stabilized then.

"Interest rates are as low as any of us have ever seen them and likely are as low as any of us will see in our remaining lifetimes."

Over the past year interest rates dropped even further. Just another example of the author not being able to see clearly.

"Housing inventories are above historical averages, thus selection is high, but I want to point out that inventory has started to decline."

Housing inventory is higher now than it was then.

" Finally, with the soon-to-expire tax credits, the government is paying you to buy a house."

It was obvious to many thinkers that the buyers bribe ($8,000) was distorting house prices. Many overpaid to get that bribe and now a few months later are upside down.

The key piece of information that author missed was wage growth. If instead you compared house prices to incomes inflation adjusted house prices remained pretty constant until the bubble. The bubble came from stupid financing schemes and ridiculously low interest rates anyone alive could get. Those policies will not be repeated for a very long time. The banks can not afford to.

according to Robert Shiller, an economist and bubble-spotter, house prices were virtually unchanged in real terms between 1890 and the later 1990s, before almost doubling in the ten years between 1997 and 2006.

Graph: U.S. housing prices, 1890-2008

You may think that the graph below shows the end of the bubble. Prices will go up right?
Here are graphs of inflation-adjusted, historical home prices. up through 2010 from 1970

NOT if you look at this chart. It shows the lifecycle of a bubble and a return to normal before going back down is expected.
Lifecycle of a Bubble

Now that we have seen the charts explain how using incomes, monthly payments, and historical data house prices can increase as interest rates rise.
  • December 13 2010
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Ahh, 6th street.  I agree, many States would not allow lenders to have homeowners suck out equity with cash-out refi-  Texas included and in turn these areas did nto fully run to peak pricing like other states.  Austin is beautiful and the enxt growth capital of the world.  Watch how many companies leave CA for Austin over the next 5 years. 
  • December 13 2010
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Hi James, I don't disagree with your points. I'm in Austin and our values are in line with historic salary ratios, so I should have added the caveat that I'm speaking from a local perspective, and for Texas in general. I'm not that knowledgeable about the specifics of other markets, so what I said may only apply to areas that skipped the bubble. Others may have further to fall, but I think that would be happening, as it has been, whether interest rates rise or not.

Steve
  • December 13 2010
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Steve, interesting but when you look at the curve, interest rates should be much higher already and are being kept artifically low through fed measures.  If you want to apply charts and historicals - we need to go back to basics.  Traditionally, you could afford a home at (max) 3 times annual income.  Due to lending programs put in place to feed a securitization model that was not sustainable proeprty values peaked at 4.3 times annual median income (if you ain't got to show income docs - you could afford anything) during 2006.  We have yet to get back to the traditional line of 2.6 - 2-8 times median annual income.  Thus, regardless of interest rates and the lack of true wage growth over the past 10 years means properties are still overvalued and an increase in interest rates pushes the affordability that much further away due to monthly debt service.  So, it may be more understandable that it is not interest rates keeping folks from the markets, it is the entire affordability level and the only event that will change this our housing prices falling back into trend lines.  When we look at the 10 year median home value in NY you can clearly see that housing still experienced a 100% increase or better.  Wages in NY have grown at best at 1.5 - 2%.  When housing corrects to reflect median incoem we shoudl expect a flat line period for 5 years to suck out the excess from the market and for subsequent price increases to be tied to median incoem and wage growth.  If interest rates are again tied to free markets at this point we should expect and average 30 year mortgage to return to 8%.  Sorry!
  • December 13 2010
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I know it seems counter-intuitive, but when interest rates start rising, buyers who have been fence sitting start worrying about losing the low rate and get into gear. That creates additional demand, demand causes price increases. 

And if one believes that an inverse relationship exists between home prices and interest rates, then why have interest rates and prices bottomed simultaneously the past several years? And why did values rise steadily from the 1970s through 2001 when interest rates mostly increased through that time period? 

Rather than lay out the entire argument, I'll provide a link to an article that explains it.
Housing Prices and Interest Rates: Do the Math - BusinessWeek

Over the next 5+ years, both interest rates and prices will rise because neither has anywhere left to go but up. It ain't any more complicated than that.

Steve
  • December 13 2010
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Profile picture for hpvanc
Larry,

What are you seeing that makes you think that mass histeria in a local market could lead a local market to defying strong national and global pressures?  I would think that we have been sufficiently burned by the events of the past decade that we will not see another bubble and collapse like we are in again in our generation.  What are you seeing that I am not?
  • December 13 2010
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There's no esy answer to your question as real estate differes from area to area. Live in the middle of nowhere? Then risign interest rates will likely exert downward pressure on prices. Live in a highly desireble and sought after area and risign interest rates may spark a Sellers market as Buyer become anxious to get in before they go even higher.

Generally speaking it's safe to assume that if rates go up it's probably going to limit values from going up and may in some cases drive them down, but there's no answer that you can get that will work 100% of the time for 100% of the properties in your market.
  • December 13 2010
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Sorry; typing error; 1 net migrant every 35 seconds.
  • December 12 2010
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Profile picture for blank screen EXILED
I think the answers already given have been very thorough and there is little else to say.

Yes, high interest rates cause inflation, but try as they might, the FED has not been able to create inflation in this recession even with the "printed" money and neither has congress with the increase in Government spending of borrowed money, mostly because the problems is not "money supply", but deficit spending, spending of imaginary equity, creation of a housing bubble through "nothing down, no qualifications" loans, and tax policy that has encouraged exporting of jobs for decades.

Throwing more imaginary money at it will do nothing to address these issues.  The bubble has to deflate, and tax policy has to be changed to bring jobs back, and deficit spending has to be curtailed.  But in the short term, the lending industry and the money supply is controlled by the government, thus below market value interest rates on loans will continue to be available for a while, and as the interest rates creep up, it is not due to "inflation", especially in the housing sector, so the bubble decline will continue, and prices will decrease faster as Dan mentioned, until the historic norm of price to income ratio is reached.

Congress and the Fed have both indicated that they will continue meddling in the loan industry and the housing market for the foreseeable future, which means they are actually trying to delay the bubble decline, so you may see some fluctuation in housing prices for a period of time, but they still ultimately are trending down across the nation, and nothing the government or the Fed can do will change that.  Ultimately, the can only affect the long term value of the dollar.  But different sectors move at different rates, so even if they get the inflation they've been trying to stimulate, housing will remain essentially flat after the decline, especially after adjusting for inflation.

Remember, the real issue with any price setting is "demand"; no demand, there is no price.  And for housing, that means "how many households"?  The country overbuilt over the last decade; there is a housing surplus.  And households are "consolidating" due to lack of jobs.  And retiring baby-boomers are liquidating housing, some going to "assisted living".  310.9 million people in the U.S. presently.  1 birth per 7 seconds (they are not buying for 20+ years).  1 death every 12 seconds.  1 net migrant every 13 seconds.  Net gain of 1 per 13 seconds, or 2.4 million increase per year.  That is only 0.78% increase per year, or 8% in a decade.  So even if the demand for housing increases at the same rate (8% per decade), this will take over 10 years to use up the existing surplus, and the builders have not stopped building, nor will they.
  • December 12 2010
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Profile picture for the_country_hick
Mortgage rates are defined by treasury rates. Once treasuries saw higher interest rates after QE2 (print more money from this air) was announced mortgage rates also went up.

There is no way to say investors will not doubt the governments ability to pay them back and demand much higher interest rates. If (or when) that happens mortgage rates could skyrocket.

My bank account could give 0.5% and mortgage rates could cost 17%. The federal reserve can hurt me in the bank account but can not completely control treasury rates or the attached mortgage rates.
  • December 12 2010
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Profile picture for the_country_hick
Joan, the answer is really simple. Going back to junior high it comes down simply to doing the math. What does the math tell us about the effects of higher interest rates on purchasing ability?

Lets look using a T--- mortgage calculator using $100,000 borrowed with no add on costs like PMI, taxes, and insurance. Just the cost of borrowing money on a yearly amortization nothing more.

A $100,000 mortgage at 4.25% costs $491.94 a month.
A $100,000 mortgage at 5.25% costs $552.20 a month.
A $100,000 mortgage at 6.25% costs $615.72 a month.
A $100,000 mortgage at 7.25% costs $682.18 a month.
A $100,000 mortgage at 8.25% costs $751.27 a month.

You can easily see how a 1% change in interest rates brings up the mortgage payment each month.

Now lets look at it in reverse. Purchase price with a close to identical cost per month.

A $100,000 mortgage at 4.25% costs $491.94 a month.
A $_89,000 mortgage at 5.25% costs $491.46 a month.
A $_80,000 mortgage at 6.25% costs $492.57 a month.
A $_72,000 mortgage at 7.25% costs $491.17 a month.
A $_65,500 mortgage at 8.25% costs $492.08  a month.

You can see how a slightly higher interest rate increase can greatly reduce what a given amount of money can buy when using borrowed money.

There are 2 ways this can go.

1 interest rates rise, incomes rise enough to offset those extra costs so prices remain constant.

2 interest rates rise. Incomes do not rise enough to make up the difference. If incomes rise by 2% and interest rates increase buying costs by 23% there is no way that wages can offset interest rate costs. Prices must drop or sales will stop at desirable levels.

Honestly, in this economy today with around 17% true measured unemployment and underemployment I do not see wages being able to increase by a large amount. Add in international competition and it becomes even less likely.

Also, people tend to buy at the top of what they can borrow. Thus when what they can borrow drops what they can pay drops also.

This is what is called buying power. Higher interest rates takes that power away when using borrowed money. Conversely when using cash it increases what should be able to buy as prices are determined by borrowed money using financing to purchase houses.

Does this answer your question well enough?
  • December 12 2010
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Do the price to income multiple for the zip code the house is located within.  Just take the median income for that zip code, multiply by 2.8 and the resulting number is what the median housing price will be in 2012.  Historically, as interest rates move higher - you can afford less home do to the higher debt service.  housing will continue to correct until the PTI is back to the historical trend.  the end result... if ylou ahve to prove inc ome to get a mortgage than housing prices will only grow alongside wage growth after putting in a bottom. 
  • December 12 2010
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Profile picture for hpvanc
Joan,

Pressure on home prices to rise and fall from a historic economic perspective have remained relative to income, and to some extent relative to disposable income rather than gross or net.  So even if we do see a rise in both inflation and income, there will still be lag in housing prices until historic income catches up with current housing prices in most US communities, and the Case Shiller index indicates that even when they do grow together, there is usually a lag, (I would hypothesize that it is also true on other big ticket items as well) while people deal with the shock of the sudden inflation.  If we have stagflation general inflation without rising wages, housing prices will definitely continue to fall until wages catch up. 

I know you didn't ask about these scenarios, but if we have stagnation where inflation is between 0% to 2% annually, interest rates will remain in their current range, and housing prices will continue to fall until they have reached historic parity with a communities income.  If we see real deflation, the worst scenario of all (think Great Depression) rates will drop further, and housing prices will continue spiraling down with no end in sight.  Japan has been stuck between these 2 scenarios, but closer to the former scenario for 20 odd years now, based on similar factors to what the US experience 4 years ago, and the US was stuck in a similar situation for 30 years at the end of the 19th century, which incidentally is known as a golden age in US history.
  • December 12 2010
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Matt, I tend to agree with you but when I have suggested that as interest rates rise, prices will come down further, I had some people who disagreed for various reasons-  some of which I didn't quite understand because economics is something I understand on a basic level, but I am certainly no expert.
  • December 12 2010
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Profile picture for Fxdlmatt
Joan,

I have a pretty simplistic view of the impact of rising interest rates on the average consumer:  Today I have $XXXX to contribute to a mortgage, if interest rates rise and home prices stay the same (and I don't get a large salary bump and/or no inflation)--I get less house.  But if most consumers are in a similar situation to mine, everybody would be "getting less house"--the economics don't work at this point.  Prices would need to come down to compensate.

--Matt
  • December 12 2010
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