The average rate on a 30-year fixed rate mortgage has risen to 4.32 as of Friday. This is up from 3.5 percent a year ago, according to Freddie Mac. These higher rates, combined with soaring home prices and a light inventory are keeping buyers out of the market. This is hurting sales of previously owned homes and stalling the recovery of the housing market. The extremely low mortgage rates that millions of Americans locked in during past years are discouraging many people from buying another home and giving up their rates from the time period which included some of the lowest rates ever recorded.
This phenomenon, called interest rate “lock-in” by economists, could cause home sales across the nation to decline. This is a huge contributor to economic growth, and without a healthy turnover of homes first-buyers may not be willing to enter the market, and existing homeowners may not want to trade up as they would’ve with lower rates.
This “lock-in” phenomenon will likely increase if interest rates rise as they are expected to up to 6% by late next year. This article references a study by Hendershot et al that investigated housing turnover from 2005 to 2011 in Cook County, IL. The statistical model found that if home prices rose by 10% in one year, and interest rates climbed one percentage point annually for the following three years, the housing turnover in strong markets fell by 75%. This is very similar to the environment we could be facing in the near future, so we will see how the housing market responds in the coming year(s).
Full article at: http://www.washingtonpost.com/business/economy/rising-interest-rates-slow-down-housing-sales/2014/03/21/567817fc-b037-11e3-9627-c65021d6d572_story.html
4 Comments
Is this analysis credible? My own reading is that it is either a blatant sales pitch – buy now! – or incompetent (and more likely both).
First, for the current doldrums, what is the impact of the rate rise, and what are alternative explanations? For a 30-year fixed-rate mortgage of $250,000 then at 3.5% the monthly is $1,123 while at 4.3% it’s $1,237 or a $154 increase. Yes, that’s 14% (about ⅐) so could have an impact, assuming no offsetting factors (the house you’re selling has gone up in price, more people with jobs, rents are up, population is up, housing stock isn’t). But then there’s the weather, and the sense that price aren’t going up as fast, so why rush…
Then there’s the second part of their story, a (second) collapse in housing is just around the corner. So let prices increase 10% (or is it 33% – 3 years running of 10% increases?) and mortgage rates go to 7.3%. Then you’re needing a $275K mortgage (and if I interpret their increase correctly, it’s actually $332,500). Then you need $1,885 a month (or $2,281 a month). That’s $648 more ($1,044 more), which is clearly not small.
However, they must be using a (partial equilibrium) micro model, basically just using a price elasticity of demand. But what sort of conditions would produce such a combination of price increases and interest rate increases? By itself, an interest rate of that level would cause a recession, but that’s not compatible with their price increase. An uptick in inflation plus an increase in real growth rates could however lead to a 300 bp mortgage rate hike and housing price increases. That combination however would mean that nominal incomes would be higher (real boost plus inflation add-on) and it would be easier to sell existing houses, and household formation would be up with more people getting married, and so on and so on. But then the housing collapse story collapses. The claimed empirics don’t hold water. (I guess that’s better than being underwater – wait, fewer would be underwater given the macro that would give such prices and rates!)
I had written this post without reading Minh post yet. But I assumed it was relatively credible, since it was posted in the Washington Post. Not that journalists have an economics degree, but I figured they would at least research what they were doing before publishing it. I don’t see what incentive a journalist would have in telling people to buy homes now, but I suppose that could influence it too. I see what you are saying with the contradictory nature of increased housing prices and interest rates. However, that is assuming that most Americans consider economic trends in their decision to purchase a home. I would like to think that people would do this, but many Americans are stupid and irrational. So possibly after saving the amount necessary for a down payment, they hastily choose to buy houses and do not consider the increased rates? So demand could maybe stay steady or increase, driving housing prices up although interest rates increase due to the excitement and irrationality in buying a house? Again, I’d like to think otherwise, but I am just trying to answer your question of what could cause this combination of P and i increases…
Ref Minh’s post! – though you mayhaps have written them simultaenously.
The story in the article could be true, but I can definitely think of many other alternative explanations. In addition to the ones mentioned by Prof. Smitka, another explanation I have in mind is that people may expect interest rate to come down in the future, since the Fed has promised to keep the interest rate low. Whether the Fed will succeed or not in boosting private investment and employment by keeping interest rate low is not the question here. However, its announcement might have led people to think that the interest rate is temporarily high, so they wait to buy houses. Again, the article would be more credible if it mentioned other possibilities.
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