Understanding the Relationship Between Mortgage Rates and Home Prices
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Chapter 1: Introduction to Economic Trends
In this new series, we utilize a couple of visuals to shed light on intriguing economic phenomena. Today, we focus on the interplay between home prices and interest rates.
As depicted in the first visual, interest rates have been climbing alongside home prices. (Source: Federal Reserve Bank of St. Louis)
This scenario is somewhat atypical. In a theoretical world, we would expect home prices to decrease when mortgage rates rise, as the demand for homes declines. When mortgage rates increase, so do monthly payments. Since incomes have remained relatively stagnant, individuals tend to assess affordability based on how their mortgage payments compare to their earnings. Therefore, higher rates typically lead to a reduction in the price that buyers can afford for a home. When this trend occurs across the economy, it generally results in falling home prices.
However, due to the historically low rates over the last decade and the ability to refinance as rates fell, many home buyers are currently locked into 30-year fixed mortgage rates ranging from 3% to 4%. They have little motivation to alter their situations. Furthermore, the yield on their savings (like those in money market funds) is now at least 1% to 2% higher than their mortgage rates. Coupled with the surprising resilience of the U.S. economy—characterized by steady growth and low unemployment—there are few, if any, motivated sellers in the market.
Without the pressure to sell, sustained price declines are unlikely.
Section 1.1: Current Home Affordability Challenges
As illustrated in the second visual, home affordability is currently at an unprecedented low. (Source: Author's calculations)
Here, I've analyzed the monthly mortgage payment for a 30-year fixed loan on the average U.S. home over the last thirty years. Throughout most of this period, despite the consistent rise in home prices, affordability remained manageable because mortgage rates were generally declining.
That trend changed in 2020, when the pandemic-induced surge in home prices took off. Last year, the Federal Reserve's rate hikes caused mortgage rates to soar. Contrary to expectations, the anticipated crash in home prices failed to materialize. Instead, we are witnessing a combination of high home prices and soaring mortgage rates (which escalated from below 3% to over 7%), placing us in the least affordable housing market to date. Ouch!
This video titled "Mortgage Rates TANK | Housing Market Death" provides insights into the current state of the housing market and the impact of rising mortgage rates.
Chapter 2: Future Outlook on Mortgage Rates
Looking ahead, many analysts suggest that mortgage rates may begin to trend downwards, which could alter the landscape of home prices.
The video "Mortgage Rates Are Headed Lower" explores the potential future changes in mortgage rates and their implications for the housing market.