When Lower Mortgage Rates Don't Boost House Prices

There's been some very good commentary in recent days about whether a reduction in mortgage interest rates might help boost house prices. Counterintuitively, the answer seems to be that there's a good chance it won't:

A 2006 study of mortgage rates and New York City housing prices going back to 1975 by Lucas Finco of Quadlet Consulting found no correlation between lower mortgage rates and higher housing prices, or vice versa. "The relationship between mortgage rates and home prices is pretty obscure," says Jack Guttentag, a professor emeritus of finance at the Wharton School of Business.

James Hamilton, a professor of economics at the University of California, San Diego, says he used to think that lower mortgage rates were responsible for rising home sales in the first half of this decade, and for that reason he projected home prices would rebound in 2007. He now says rising home sales were the result of deterioration of lending standards and not lower mortgage rates. "I was wrong. The real story with home sales has to do with the availability of credit," says Hamilton. "And credit is tight now."

Calculated Risk gets a bit wonkier: yes, he says, lower mortgage rates help tilt the balance of the rent vs buy calculation. But:

Landlords, already struggling with high vacancy rates and falling rents, would probably lower their rents further and make the rent vs. buy decision more difficult again. So lower interest rates might not boost demand very much, it might just lead to lower rents.

My feeling is that lower mortgage rates do feed through into higher prices in an up market. It wasn't all that long ago that we were all bombarded with the advice to "buy the biggest and most expensive house you can afford" -- since houses always and everywhere rise in value, that's just a way of maximizing your net worth. Clearly, the lower that mortgage rates go, the more house can be bought with a monthly dollar of mortgage payment, and during the bubble, people were putting every last penny they could scrounge into their mortgage payments.

Now, however, things have changed. For all that a few brave souls are poking their heads above the parapet and wondering whether it's a good time to buy, there has been a dawning realization that maybe a strategy of deliberately maximizing your mortgage payments might have a certain amount of downside. In other words, we've gone from:

1. How much money will the bank lend me?
2. Now what can I buy with that?

to:

1. Where do I want to live?
2. Can I afford it?

In this new world, lower mortgage rates might just allow people to buy property which was formerly just out of their grasp. But that's a marginal effect, and lower prices would be more effective at that anyway. If people stop buying houses on the outer edge of affordability, then I see very little way in which lower mortgage rates are going to feed into higher house prices.

(HT: Kiviat)

Comments

[Ax:]

"A 2006 study of mortgage rates and New York City housing prices going back to 1975 by Lucas Finco of Quadlet Consulting found no correlation between lower mortgage rates and higher housing prices, or vice versa. "The relationship between mortgage rates and home prices is pretty obscure," says Jack Guttentag, a professor emeritus of finance at the Wharton School of Business."

That is not even the right question to ask. It is impossible to even imagine that a lower mortgage rate would make prices rise again right now. We all know they are going to fall further, because the inventory is to high.

The main question is: does a lower mortgage rate clear up inventory faster? I'm inclined to that theory because it allows refinancing and it lures more "greedy" buyers back into the market. West would benefit from that, since the prices have fallen to a level where sales have gone up in the past year.

2008 Dec 08 05:17 AM

[Smarty_Pants:]

As noted in the article, the speculative mania in housing has ended. The real estate mindset has changed from 'max leverage for max gain' to 'payments I can afford'. That's fine for folks on the borderline of affordability, but there are many who owe far more than the property is worth. Lowering the rate isn't going to help them qualify for a mortgage as the bank will be reluctant to refinance unless it is the only way to keep the payments coming in (even then the risk of default in the future remains high).

The large numbers of under water mortgages will only be 'solved' via large numbers of foreclosures with attendant losses for the banks (or GSEs, or USTreasury). There is no way to generate the same level of loan volume which created the bubble at 'sensible' rates and supportable loan standards. Many banks will choose to wait for a bailout instead of taking the losses.

I have an acquaintance who is trying to sell his home in a short sale. He has had two solid offers that the bank has been sitting on for several months "for approval". Both buyers would easily qualify for a standard loan at the lower price, yet the bank withholds approval for the short sale. One can only guess that they are hoping the gub'mint will somehow make them whole on their loss soon and they are therefore willing to wait and see what happens rather than complete the sale and take the associated loss.

Tinkering with rates and standards won't make the problem go away, at best it will help with a small number of borderline cases while the bulk of the problems loans will remain unaffected until prices come down and someone eats the loss.

2008 Dec 08 09:30 AM

[Did U Think...:]

Property prices are higher than they are worth and the plummeting values will continue for at least another 18 months. There is NOTHING that will get someone to buy a home which they think will simply go down more in price in the weeks and months following their purchase. Before they will even think of buying a house they have to be convinced that housing has bottomed in the market place and no sort of temporary government controls or stimulus are causing it. Everyone knows that government programs are limited time deals and if the gov't is propping up home prices the prices will continue their walk down as soon as the gov't stops or runs out of cash to continue.

After the home prices have bottomed, the next consideration is affordability (which is a PITI statement). I will repeat for the cheap seats: even if the interest on a home is low, even if the PITI is affordable on a monthly basis, people will not buy homes that they think will go down in value as soon as they step across the threshold. Homes are the biggest thing that most people will ever buy and thus they tend to not want to be underwater as soon as they sign the paperwork and take the keys.

2008 Dec 09 06:45 AM

[neocon4jesus:]

Exactly right. Until the average home price in the US reflects 2.5 times household income, homes are still overpriced.

We still have about another 2 years until the bottom.

don
Spring Green, WI Where there never was a bubble, Thank U Jesus

2008 Dec 09 11:36 AM

[Steven R. S...:]

During the perior of years when loose credit prevailed, while management at the lender were working on getting their bonuses up, and people did not have to qualify for loans: housing prices increased beyond supportable levels.

In those areas that are still over priced, low interest rates will not help. Prices will still need to come down. How much? It depends, it is a local phenom.

Can the Bottom of a Housing Market be measured and predicted? Yes both in terms of the Price Level and the Timing.

2008 Dec 09 04:55 PM

[Alphameister:]

Lowering mortgage rates will add to demand at the margin and thus tend to reduce inventory while slowing the rate of price decline. Pretty basic economics.

2008 Dec 10 06:42 PM