rise, must home prices fall?
Mortgage rates fell for three years, and home prices
skyrocketed in many parts of the country. Now that mortgage rates
are rising, people wonder if home prices will fall.
Don't bet on it.
Prices could drop in some places, sometimes in response
to economic shocks such as plant closings and sometimes from higher
interest rates. In some areas, rising mortgage rates could actually
cause a brief spike in home prices as procrastinators finally decide
to make offers on houses, only to find themselves in unforeseen
bidding wars with fellow procrastinators.
In the long run, it's impossible to predict whether
rising interest rates will push home prices downward in a particular
neighborhood. It's always hazardous to try to time markets, whether
in stocks or houses. Your best bet is to time the buying and selling
of your home based on your needs, not on what you expect the local
housing market to do.
Mortgage rates and home prices: Two theories
When it comes to mortgage rates and home prices, there are
two schools of thought.
One theory is that demographic and political trends
have more impact than interest rates, and that home prices won't
fall -- at least, not nationwide -- but the pace of price appreciation
will slow as rates increase.
The other theory places more emphasis on human nature
than on demographics and politics. It says that people know how
much they can afford to spend every month on housing, so when mortgage
rates rise, people buy less-expensive houses to accommodate higher
interest payments. When large numbers of people do this, they drive
The connection between rates, housing pricing
The theory that rates and prices are related makes intuitive sense,
and Jack Harris buys it. Harris, research economist for Texas A&M
University's Real Estate Center, notes that, at least in Texas,
every time rates dipped in the past two years, prices went up.
makes sense that the opposite will happen, because as rates rise,
"demand is going to fall off. The higher rates are probably
going to knock some people out of the market."
The way Harris sees it, a lot of home buyers have
been stretching their budgets as far as they could so they could
buy houses at extremely low interest rates. If rates rise 1 or 2
percentage points from their June lows, those prospective buyers
will either have to continue to rent (or live with their parents)
or adjust their sights downward, buying cheaper homes than they
would have been able to afford when mortgage rates were much lower.
Harris expects to see a lot of people adjusting their
sights downward when rates hit about 6.75 or 7 percent, and for
overall housing demand to fall when rates are about a percentage
point higher than that. This week, the last week of July 2003, the
average rate is a little under 6.25 percent.
Meantime, he says, rising rates could have the paradoxical
effect of increasing house prices for a while. "The market
heats up when interest rates go up," he says. "People
feel like they can't take their time; they've got to go ahead and
close the sale before rates get higher."
Indeed, that's happening in some places, says Diane
Saatchi, president of Dayton-Halstead Realty in the Hamptons of
"A lot of people realized that the deal to make
now was not with the price, but with the financing," Saatchi
says. "Now, with the interest rates picking up, everybody has
seen the bottom and they want to lock in a rate for themselves not
too far from the bottom."
Prices temporarily buoyed
As a result, sellers suddenly get multiple offers, which has
the effect of keeping prices up. Like Harris, Saatchi thinks that,
over the long term, higher rates mean that buyers will pay lower
prices for houses, in some cases settling for less house than they
would have been able to afford a few months earlier.
Most economists in the housing industry agree that
the torrid pace of home-price appreciation will slow, but they don't
foresee widespread price decreases. They point to demographic factors:
the United States is in the midst of a huge immigration boom (of
the 32.5 million foreign-born U.S. residents, almost half arrived
since 1990), and the offspring of the Baby Boomers are moving out
and forming families.
Immigration and the Baby Boom echo create a lot of
demand for housing at a time when political factors -- such as environmental
concerns and "smart growth" initiatives -- make it harder
to build new housing developments, says Doug Duncan, chief economist
for the Mortgage Bankers Association.
"It's our belief that demand is going
to increase at a faster rate than supply, thereby increasing home
prices," Duncan says.
He notes that "there has never been a full year
in the history of the modern U.S. economy when home prices have
fallen across the entire U.S. economy."
That leaves Duncan a lot of wiggle room if the housing
markets of entire states or regions go kaput for a while.