Mortgage Rates vs. Home Prices

August 1, 2011
Mortgage Rates vs. Home Prices

Mortgage Q&A: “Mortgage rates vs. home prices.”

Today we’ll take a look at the impact of both home prices and mortgage rates on your decision to buy a piece of property, along with the relationship they share.

Obviously, both are very important not only in terms of whether you should buy (from an investment standpoint), but also how much house you can afford.

Mortgage Rates Are Still Low

  • What’s more important?
  • A lower mortgage rate
  • Or a lower purchase price?
  • Let’s find out!

At the moment, mortgage rates are very close to historic lows, with the popular 30-year fixed-rate mortgage averaging 4.55 percent last week, according to data from Freddie Mac.

But while rates are low, home sales are still pretty flat, thanks in part to high unemployment, a lack of consumer confidence, and perhaps inflated home prices.

Today's Rates

Yep, even though home prices are well off their housing bubble peaks, many feel they’re still inflated.

This is made clear without the use of home price indices, fancy calculators and algorithms…just take a look at some listings and you’ll think home sellers are nuts for asking so much.

Problem is most of them are asking for prices below their mortgage balance (short sale) and still aren’t getting any bites.

Home Prices Might Be Inflated

  • Some think home prices are too high
  • Which is why mortgage rates are so low
  • But sometimes the relationship
  • Isn’t as obvious as it looks

You can’t really blame them, as most bought during the boom at ridiculously inflated prices or bought pre-boom, and subsequently refinanced to tap into all that wonderful home equity.

Getting back on point, home values have lost about a decade’s worth of appreciation, and are currently coupled with near-record low mortgage rates.

Home prices are predicted to be pretty flat over the next several years, but mortgage rates are expected to rise.

So should you buy now while rates are low and prices have foreseeable downward pressure, thanks to all that distressed/shadow inventory and lack of confidence?

Or should you wait it out and let home prices hit bottom first?

[How to get a mortgage?]

Well, first things first, it’s nearly impossible to buy at the bottom. Anyone will tell you this, whether it’s a home or a stock or anything else.

Predicating the absolute bottom, or even close to it, can be a tall order.

Home prices are also regional and local, so it’s not like home prices have fallen by the same amount throughout the country.

And not all home prices in the nation can be designated as cheap, average, or expensive – they vary tremendously.

At the same time, it’d be hard to argue that mortgage rates nationwide aren’t super low and only expected to rise.

Buy a House While Mortgage Rates Are Low? Or Vice Versa…

  • It’s possible to pay more for a house
  • While interest rates are low
  • Get a lower monthly mortgage payment
  • And pay less interest over the loan term

All that being said, let’s take a look at a scenario where mortgage rates rise and home prices slump to see which option is more favorable.

Scenario 1:

Sales price: $400,000
Loan amount: $320,000 (20% down payment = $80,000)
Mortgage rate: 4.50%
Mortgage payment: $1621.39
Total paid including interest: $583,700.40

Now say home prices fall 10 percent over the next year or two, while mortgage rates rise from 4.50% to 6.00%, which isn’t necessarily unlikely.

Scenario 2:

Sales price: $360,000
Loan amount: $288,000 (20% down = $72,000)
Mortgage rate: 6.00%
Mortgage payment: $1726.71
Total paid including interest: $621,615.60

As you can see, buying the home at the higher price with the lower mortgage rate results in both a lower monthly mortgage payment and significantly less interest paid throughout the loan.

That could also make qualifying easier with regard to the debt-to-income ratio requirement.

However, the down payment is $8,000 higher on the more expensive house, which could prove a barrier to homeownership if liquid assets are low.

But we’re still looking at savings of roughly $30,000 with the larger, yet lower-rate mortgage.

Hopefully this illustrates the importance of low mortgage rates. Of course, there are a ton of variables that can come into play.

Most people move or refinance their mortgages within seven years or so from the date of purchase, making the interest savings unclear.

And you can’t change what you paid for a home, whereas you can change your mortgage rate via a rate and term refinance, assuming rates improve since the time of purchase.

Do Higher Mortgage Rates Lead to Lower Home Prices?

prices vs rates

  • Conventional wisdom says there’s a negative correlation
  • Between home prices and mortgage rates
  • But is that actually true?
  • Just look at the many time periods where both went up

Now let’s discuss that relationship between mortgage rates and home prices, because it’s not what you might expect.

There’s a common thought that once interest rates rise, they’ll put downward pressure on home prices, meaning property values today could be artificially inflated based on the low interest rates available, which has somewhat increased demand.

This is a bit of a myth, and the image above kind of illustrates that, though the data might be cherry-picked to some degree.

As you can see, house prices don’t just fall when interest rates rise. If anything, the opposite has happened in the past.

Home prices and mortgage rates aren’t that closely correlated over time.  In fact, mortgage interest rates may not really affect the price of housing.

In other words, home prices may rise even if mortgage rates increase, despite it being more expensive to get financing.

How Do Interest Rates Affect Real Estate Prices?

  • Both may rise in tandem
  • Don’t expect a deal if mortgage rates are high
  • Or for interest rates to drop if home prices are high
  • The economy can drive both higher or lower simultaneously

Well, as mentioned, both may rise in tandem, believe it or not.

This is partially because not everyone buys real estate with a mortgage, instead using cash, and also due to macroeconomic factors. If the economy is chugging along nicely, interest rates will likely rise to stem inflation concerns.

And if the economy is doing well, home prices will also be on the rise because a strong economy means more jobs, which leads to a greater number of homeowners.

A solid economy also means the lending environment will be favorable, so even if rates rise, lenders will be doling out more loans with more flexible financing options. All that can lead to more demand and higher home prices.

So don’t just assume home prices will drop if mortgage rates rise. And vice versa.

Who knows, maybe rates will stay relatively low and home prices will fall even more than expected over the next few years.

Read more: What mortgage rate can I expect?


5 Comments

  1. Roger July 25, 2013 at 1:31 am -

    The latest Fed tinkering with mortgage rates (QE) is a unique situation, and as such, I believe home prices will fall. In recent history, rates were kept artificially low – it wasn’t due to macroeconomics, so I think prices come down as rates rise. Over time, the correlation may not be there, but with rates rising so quickly, it will have to at least slow home price appreciation. It will be interesting to see the chart prices vs. rates a year from now.

  2. Colin Robertson June 25, 2013 at 8:58 pm -

    Good point, but if demand still outweighs supply, home prices should rise. And a strong economy means more qualified home buyers.

  3. Evan June 23, 2013 at 12:29 am -

    Interesting. I figured higher mortgage rates would definitely equate to lower home prices, but I guess if the economy is improving, so will prices. But it does reduce the number of eligible home buyers…

  4. Sabrina June 22, 2013 at 7:15 am -

    Gosh, I hope the recent spike in mortgage rates doesn’t hurt the housing recovery. I see that you don’t believe it will, but I think the low rates were the only thing keeping prices up.

  5. JoeSh August 4, 2011 at 1:51 pm -

    A well thought out presentation.

    The only thing I could argue is you made a few assumptions that may not unfold.

    Interest rates may rise but with the FED and DC in control this is not a given scenario I would bet on. The one thing I will bet on is house prices continuing to fall until they come more in line with the local economy median incomes.

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