Will rising rates deflate
housing prices?By Greg
McBride, CFA • Bankrate.com  The
move to higher interest rates is breeding concern about what might happen to home
prices after an impressive run-up in most parts of the country. After all, one
of the key ingredients in home-price appreciation has been the low mortgage rates
that give borrowers more house for the same monthly payment. Homeownership rates
have also hit an all-time high as first-time home buyers have fled their landlords
and flocked to mortgage lenders.
With
mortgage rates remaining so low for so long, the prospect of higher rates affects
the affordability quotient and has a particular impact on first-time home buyers.
In addition, the increasing trend toward adjustable-rate mortgages puts many homeowners
in the position of one day seeing their mortgage rates and monthly payments adjust
higher. The National Association of Realtors' first-time home buyer affordability
index already shows a strained buyer that has just 80 percent of the necessary
income to buy a median-priced home. With mortgage
delinquency rates at 4 percent, and both credit card delinquencies and personal
bankruptcy filings at record-highs, there just isn't a lot of room in many household
budgets. The idea that future wage growth will offset the impact of higher payments
for ARM borrowers or new buyers is long on promise, but short on substance.
People still want to buy homes, and people will forever need to buy homes.
But if rates rise appreciably, the question for some would-be buyers becomes whether
they can. Reports of limited supply that will sustain home prices amid robust
demand are common. An influx of immigrants is often credited with sustaining demand.
But considering that first-time home buyers would bear the brunt of higher interest
rates, estimates for ongoing demand may prove to be overly optimistic. Nonetheless,
home prices are on people's minds. A recent trip to Long Island yielded just such
evidence. Of course, Long Island has been of the strongest appreciating housing
markets nationwide in the past several years. The common refrain among everyone
I encountered, regardless of age or financial status, was something to the effect
of "Can you believe home prices around here?" No, I could not. Indeed,
in one neighborhood I noticed homes fetching nearly $500,000, where the same style
home in a similar neighborhood in western Pennsylvania sells for $150,000.
Like many others, I have noticed that a common topic of conversation among
complete strangers from all over the country is the ridiculous level of home prices
in many areas. The last time such a topic was so prevalent was during the stock
market fervor of the late 1990s. Unfortunately, that did not end so well. While
hardly a scientific indicator, mentions of the term "housing bubble"
in the media have exploded since 2002, after barely registering in 2001. Consider
the old investing mantras to "buy on the sound of the cannons, sell on the
sound of the trumpets" or the advice that when you start getting stock tips
from cab drivers or in barbershops, it is time to sell. Does the prevailing
concern indicate that home prices are peaking? The difference between home prices
and those of other financial assets is that a house is first and foremost a home,
enabling -- or forcing -- homeowners to refrain from panic-induced selling so
prevalent in other assets. Some markets are more prone to price correction than
others. The metro areas of San Francisco, Boston, New York City and Washington,
D.C., are often mentioned, citing the escalation of home prices to near-stratospheric
levels. Most economists and housing experts seem to agree that there is
very little risk of a nationwide housing bubble. They repeatedly cite 8 percent
as the mortgage rate tipping point, one that could trigger a widespread drop in
home prices. But rates are currently near 6 percent, far removed from such dangerous
territory. Indeed, most markets aren't in danger of falling prices, but will likely
settle for a more moderate pace of appreciation in the years to come. With
mortgage rates rising but still at very attractive levels, any alarm about the
impact on home prices might seem premature. But with household budgets tight,
first-time home buyers stretching thin and taking on ARMs in increasing numbers,
and so many people expressing concern about the meteoric rise in home prices,
some caution is warranted. Any time prices get ahead of fundamentals -- whether
you're talking about tulip bulbs, stock prices, or home values -- those paying
the highest prices bear the most risk. Greg
McBride is a senior financial analyst for Bankrate.com. | 
