Aug292014

Are low house prices better than low mortgage interest rates?

Both low mortgage interest rates and low house prices reduce ownership costs for financed buyers, but which one is better?

dude_you_paid_too_muchWhether low house prices or low interest rates are better is a matter of perspective. From a lender’s point of view today, low mortgage rates and high prices are better because they have so many underwater borrowers putting their capital at risk. Historically, lenders would prefer higher rates because interest is income, and they would rather make a higher rate of return by charging a higher interest rate, but the problem with underwater borrowers has shifted their preference.

From the perspective of taxing authorities, lower mortgage rates and higher prices are always more desirable. Municipalities get their revenues from property taxes, so they want to see land values as high as possible. Proposition 13 was supposed to prevent State and local governments from taxing people out of their homes, but instead Proposition 13 prompts lawmakers to support policies that inflate house prices as much as possible to regain the lost tax revenue.

Most economists erroneously argue in favor of lower interest rates generally as a stimulus to the economy; however, low interest rates cuts both ways because the interest cost to a borrower is income to a lender. The federal reserve’s zero interest-rate policy has crushed seniors living on fixed incomes. Their policy takes money away from seniors, which prevents them from spending this money on goods and services, and instead diverts this money to loanowners who enjoy a debt-service subsidy. Where is the economic benefit in that?

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So that opens the larger question about which is better, lower prices or lower interest rates? Both lower the monthly cost of ownership and result in more disposable income. Obviously, the banks prefer higher prices to recoup their capital from their bad bubble-era loans, so they are offering 4% interest rates to prevent prices from going any lower. I think most buyers would prefer lower prices, but since the banks make the rules which determine market prices, low interest rates and high prices are what we get.

From a homebuyers perspective low rates or low prices depends on how they acquire the property. All-cash buyers would far prefer lower prices because they gain nothing from cheap debt they don’t use. From a financed buyer’s perspective, lower interest rates are better even if they pay higher prices.enlist_mortgage_drowning_underwater

If a financed buyer holds a property for 30 years and pays off the debt, how they financed the property doesn’t matter; however, if they sell the property before paying it off entirely, low mortgage rates are superior because they amortize faster. Assuming equal rates of appreciation during the holding period, a financed buyer using a low mortgage rate will accumulate more equity than a buyer who pays a higher mortgage interest rate; that’s the math. The key question is whether or not appreciation rates would be the same.

Buyers who purchase during a period of high mortgage rates may get the boost in appreciation from declining rates, so they may enjoy more appreciation than a financed buyer who buys today when mortgage rates are low. Over the last 30 years, declining mortgage interest rates added significant appreciation above and beyond the growth in income. The current generation of buyers won’t get the same boost.

Low mortgage rates build equity faster through amortization but slower by appreciation. High mortgage rates build equity faster by appreciation but slower through amortization.

Which do you think is better?

What matters more to housing: Price or rates?

Diana Olick, August 26, 2014Debt_demands_soul

There has long been a saying in the real estate market that potential homebuyers don’t buy according to the home price or the mortgage rate. Instead, “they buy the monthly payment.” The monthly payment is, of course, a combination of rate and price, but the weight of each can change dramatically.

For example, home prices were able to soar uncontrollably during the last housing boom only because risky mortgage products at the time made monthly payments minuscule and down payments often nonexistent.

Of course when those monthly payments turned into pumpkins, the housing market came crashing down.

That’s a great synopsis of the housing bubble and bust. The property rating system on this site is based entirely on the monthly cost of ownership, and my monthly market updates compare this to historic norms to determine whether markets are overvalued or undervalued relative to rent.

A dramatic rise in home prices, like we saw last year, can slow home sales even when mortgage rates are low if mortgage availability is tighter. That’s what we saw in the first half of this year.

Actually, what we saw starting last summer was the housing market hitting the ceiling of affordability.

Fast forward to today. Mortgage rates are near historic lows and haven’t moved much in the past year, since jumping a full percentage point from their bottom in the late spring of 2013. Home prices, which jumped by double digits in 2013, are only now beginning to ease. …

Sellers are, in fact, reducing the list price at a much higher rate than at this time last year, according to Redfin, a real estate brokerage and analytics firm.

“Sellers are finally getting the word that this is a different market than 2013,” said Nela Richardson, Redfin’s chief economist. “We are seeing the gradual end of multiple offers, and escalation clauses are becoming a thing of the past in all but the most desirable markets.”

(See: It’s no longer a seller’s market)join_debtors_adjustable_rate_mortgages

That leaves mortgage rates as the wild card as the housing recovery enters the fall season, a period historically driven by first-time buyers. Those buyers have been disproportionately hard hit by the recession and slowest to return to the market. Rates are still low, but buyers today are extremely sensitive to the slightest moves.

(See: Future housing markets will be very interest rate sensitive, and Mounting evidence of housing market’s extreme sensitivity to mortgage interest rates)

“It never ceases to amaze me how hung up mortgage borrowers can be on rate,” said Matthew Graham of Mortgage News Daily. “In fact, a lot of times we have to remind them that the .125 percent difference in rate only amounts to X dollars and they’re surprised.” …

Rates are not at rock bottom, so there is no great incentive for a buyer to jump now to take advantage of the lowest rate. They are also not rising, so there is no incentive to buy based on fear that rates will go higher. The argument could also be made that rising rates would be the outcome of an improving economy, and that improvement would be a stronger driver for homebuyers … stronger than the extra cost of rising rates in a monthly payment.

(See: Will rising wages offset the impact of rising mortgage rates?)

All of this is why there seems to be equal gangs of bulls and bears in the housing market today. Some claim affordability is still good enough to drive demand through the fall and into 2015. Others claim rising rates, weak income growth and a conservative lending environment will stall the market in its tracks. And that’s just the demand side. The supply side is another story.

I would feel better about the so-called housing recovery if it weren’t the result of constant market manipulation by lenders and our government, but I have to live in the world we have, not the one I would prefer to live in.

I don’t think low rates are as desirable as low prices, but they do serve as an adequate substitute. Both low prices and low rates can lower monthly costs and stimulate consumer spending. That is what will ultimately make the economy recover.

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[listing mls=”NP14077077″]