Zillow: Coastal California house prices may decline as mortgage rates rise

 Coastal California real estate will be among the most susceptible to problems with affordability due to rising mortgage rates.

clean_you_outMortgage rates went down from 2007-2009 because it was necessary to save our banking system — or at least to save the assets of the idiots in charge. Lenders inflated a massive housing bubble based on debt, and the total amount of debt created was far greater than what incomes could support. Since there was no way borrowers could reasonably make payments, it was necessary to lower the payments significantly in order to prevent delinquencies from getting any worse than they did.

In 2006, the payments on a mortgage at 6.5% mortgage rates consumed well over 60% of a borrowers gross income, but if refinanced at 3.5%, the debt-to-income ratio falls to a manageable 31%, a payment level borrowers can support.

Wages have risen about 20% since 2006, and mortgage rates still hover near 4%. At those levels, borrowers can barely hold on, but the debt levels prove manageable as delinquency rates continue to fall. Each time mortgage rates have risen over the last three years, home sales have declined. As it stands today, the housing market depends entirely on interest-rate stimulus.


If interest rates go on a sustained rise, financing home purchases will become more expensive. The real question then is whether or not these rising costs due to rising interest rates are compensated for by rising wages. If wages rise as fast as interest rates do, then borrowers will still be able to finance large sums, and house prices can remain stable or even rise. However, if wages do not rise as interest rates go up, then loan balances will decline, and house prices will fall again.

This effect will not be uniform across every housing market in the country. In markets like Florida, Chicago, or Nevada, rising mortgage rates will be hardly noticed. These markets are much more affordable than normal, so rising mortgage rates won’t impact the ability of many local residents to finance a home purchase; thus both sales volumes and appreciation will continue in those markets.coastal_california

The markets that responded the best to efforts to reflate the bubble over the last several years are those that are the most sensitive to interest rates. Further, these markets are also valued the highest relative to borrowing power of local residents. As mortgage rates make these markets less affordable, at first home sales will crumble, but then house prices may follow.

Analysts at Zillow are of the opinion that markets like Coastal California will experience the biggest negative impact from rising mortgage rates.

Rising Mortgage Rates to Test Housing Market’s Strength

Homes in pricier cities could be out of reach of more buyers

By Laura Kusisto, June 21, 2015Yellen_fed_reflation

The housing market could be in for a bumpy ride as mortgage rates climb. …

While modest increases in interest rates are certain to knock some buyers out of the market, many economists believe most home buyers will hang in—at least for the near term. The reason: The monthly cost of an average-size home remains relatively affordable when compared with average incomes. Apartment rents also have risen sharply in recent years.

But higher rates could spell trouble for pricier West Coast cities, such as San Francisco, Los Angeles and San Diego, where home prices are already out of reach of many residents and would only be made worse if mortgage rates rise.

In Los Angeles, for example, with mortgage rates at 4%, a typical household would have to spend 41% of its income on mortgage payments to buy a house for the median price in the area, according to Zillow. If rates rise to 5%, that household would need to spend 46% of its income to afford mortgage payments.

Similarly, in San Francisco, a typical household would go from spending 43% of its income with mortgage rates at 4%, to spending 48% with rates a percentage point higher.


By contrast, in a cheaper market such as Chicago, a typical household must spend 14% of its income on mortgage payments with rates at 4%, according to Zillow. That would climb to just 17% with rates at 6%.

The rule of thumb is that no more than 30% of a household’s income should go to housing costs.

Over the last few years as I’ve watched house prices move high and higher here in Coastal California, I occasionally second-guessed my decision to invest in Las Vegas as opposed to buying a house locally. To date, either investment would have turned out well. If the impact of rising mortgage rates has the impact forecast above, I will feel fully validated in my decision.Prices_going_down

The result for these overpriced markets will be less of a pop and more of a fizzle. Economists expect that prices in those places will mostly likely flatten out or decline slightly, which may help keep the markets from overheating. “It’s almost like someone pouring cold water on some of these hot markets to cool them down,” said Svenja Gudell, Zillow’s senior director of economic research.

At current mortgage rates, homes in all top 30 metro areas are either undervalued or fairly valued at current prices, according to John Burns, chief executive of John Burns Real Estate Consulting Inc. …

“I’m worried about it,” said Glenn Kelman, chief executive of Redfin, a real-estate brokerage. “The rates have been so low for so long that trying to persuade anyone that 4% or 4.5% is still a bargain may not be easy to do.”

I find it comforting to hear that homebuyers are not as easily duped by realtor sales ploys to generate false urgency.


This time, economists said the economy overall is in better shape to handle increases. But that may not be true everywhere, and homeowners in California should brace for a gradual end to the boom times.

What? An end to boom times in California real estate? I can assure him that nobody in California is expecting that.


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