There are many reports showing increasing home prices of 5% or more; for 2012 Case Shiller, Core Logic, NAr, Data Quick, and many others. In addition, it seems like home builders are having a rally as their stock prices have increased. However, there is one overall factor that determines home values. The main driver of this increase are mortgage rates, the cost of renting money from lenders. The home values increases not due to economic activity, increased wages, easy credit, or some sort of miracle recovery. Since 2007 mortgage rates have dropped almost 40% at the end of 2012 where they were at all time lows. This has increased the average buyer’s purchasing power so much that it stopped the Orange County median home prices from reaching pre-2000′s values.
The main determination of home values are not comparable sales, it’s mortgages rates and household income originated into a 30 year fixed loan. A home’s value is a reflection of the mortgages rates and consumer trends. The graph below has mortgage rates versus median values for Orange County between 1988 to 2012. You can see in the late 1980′s and early 1990′s there were higher mortgage rates and home values were low and very stable. Not until the early 2000′s did you see a large increase in home values that was much larger compared to the drop in mortgages rates. At this point in the last decade so you see the effect of affordability loan products to increase home values. These products made income and underwriting irrelevant. Teaser rates or negative amortization pushed payments much lower than any fixed rate mortgage could and it greatly magnified the affect of these low rates.
In fact, home values should have dropped into the mid to late 1990′s median value as income also dropped. However, a nearly 40% drop in mortgages rates from 2007 to 2012 stopped this from happening, see Table below. Loan modifications, FHA, and the withholding of shadow inventory by banks also played a major in keeping home values from slipping back into the late 1990′s. A 5% increase in home values compared to a 40% dropped in mortgage is just background noise and not significant increase in home values as espoused by all the media. If you think this increase was the result of us coming out of the recession, think again incomes have actually decreased 8% from 4 years ago. This is clearly the case of increased affordability.
|Table of Purchasing Power|
|Year||Household Median Income||Mortgage Rates 30 year fixed||Debt to Income Ratio||Eligible Loan Amount||Monthly Payment|
For the past 12 years $70,000 has been median household income in Orange County with little variation. The proposed Qualified Mortgage uses a debt to income ration of 43%, but I reduced by 9% that will be used to pay for property taxes and insurance. You can see in that in 200o the median household income could afford a $266,631 loan, but in 2012 the same household could afford a $429,014 loan. That’s a 61% increase in purchasing power! Since 2007 there has been an increase of 35% in purchasing power, that is very short time to have such an increase. Therefore what is an a 5% increase in home values compared to this drop in mortgages rates. In fact if mortgage rates maintained their 2007 borrowing rates into 2012 we would have seen Orange County median values dip below $300,000 to 1990′s values.
Will we go back to 1990′s values? It’s really anyone’s guess, however the banks and federal government have spent the last 5 years trying to decrease mortgage and withholding housing inventory and have been extremely successful at this task. I don’t believe they will let mortgages increase into 8% to 10% range even if it causes massive inflation. Inflation and more importantly wage inflation might be their plan to keep these home values high and bailout out the banks’ 5 million non-performing loans. If you are buyer with a time frame of greater than 10 years it might cheaper to purchase a house with a 15 year loan now, then to wait for a possible drop in home values due to higher mortgage rates. The cost of borrowing is just that cheap.