Higher prices and rising interest rates will slow housing market appreciation

The restricted inventory condition we are dealing with here in the Southwest has caused prices to go up. However, for buying to keep pushing prices higher, interest rates must keep falling to sustain affordability at higher price levels. In a market like ours where demand is less than robust (most increased demand this year came from all-cash investors and hedge funds), any decrease in affordability is going to hurt sales. At first it will show up in decreased sales volumes. If affordability continues to crumble, prices will begin falling again.

Housing Affordability Begins to Slide

Published: Tuesday, 11 Dec 2012 | 12:21 PM ET

By: Diana Olick — CNBC Real Estate Reporter

It is a double edged sword, no doubt. Rising home prices are necessary for the overall housing market to recover and for more borrowers to get back above water on their mortgages. Rising home prices, however, cut into the historic affordability that was bringing more buyers back to the market in the first place.

After rising steadily since 2006 (with a slight blip from the home buyer tax credit in 2010), housing affordability is now dropping on an index from the National Association of Realtors. Asking prices for homes also began rising faster than rents for the first time in November, according to Trulia.

“The era of increasing homeownership affordability in big cities is ending,” researchers from Trulia wrote in a recent report. While the price recovery is choppy market-to-market, strong rental markets like Denver, Seattle and San Francisco are seeing home prices leap ahead of rents.

Rising prices can be offset by falling interest rates, but once those start going back up, either affordability will plummet or appreciation will slow or perhaps reverse.

Some pundits believe the housing market will sustain itself despite rising prices and falling affordability. Evidence from mortgage originations says otherwise.

Rising Mortgage Rates Spook Housing

Published: Wednesday, 19 Dec 2012 | 11:21 AM ET

Even with mortgage rates hovering near record lows, it doesn’t take much to send borrowers running for the hills.

A slight move up from 3.47 percent on the 30-year fixed to 3.50 percent, caused mortgage refinance applications to plummet 14 percent from the previous week, according to the Mortgage Bankers Association.

Despite the Federal Reserve’s announcement last week that it would purchase an additional $45 billion in Treasury securities per month as part of its continuing quantitative easing effort, rates increased in the second half of the week,” said Mike Fratantoni, MBA’s Vice President of Research and Economics.

The Law of Diminishing Returns is setting in. Each round of quantitative easing is having less and less effect on the economy and on mortgage interest rates specifically.

“As a result, refinance applications dropped sharply to the lowest level in over a month.”

Applications to buy a home also dropped 5 percent week-to-week, indicating a still weak and rate-sensitive purchase market.

This is the most telling indicator of the health of the housing market. Demand from owner-occupants still has not broken out of its tight range at 1990s levels.

“A lot of money has been spent between OT [Operation Twist] and QE3 for very little incremental reward,” notes Peter Boockvar of Miller Tabak. “The true cost, yet to be determined, will of course occur when the likely market forced exit begins.”

The federal reserve is printing money to prop up nominal house prices. In the end, they may succeed, but in doing so, they will create a great deal of inflation. The result will be lower house prices on an inflation-adjusted basis, but few seem to care about that. Taxpayers aren’t the ones picking up the tab for inflation. Savers are.