Rising Mortgage Rates. Are We in Trouble?

Yesterday we dispelled the myth about a potential new housing bubble forming right now. The reasons had to do with the fact that even though housing prices are up, they are still down substantially from the prices of 2006, inventory is starting to grow, and mortgage rates are rising—which will slow down what people can pay for a home.

Today let’s first discuss why the rising interest rates will indeed slow things down. Look at this chart:

August2013-15

This shows us how much a buyer will have to spend each month on principal and interest based on the price of the house he wants to purchase and the differing mortgage rates. Let’s suppose a buyer wants to keep his monthly housing expenses at around $2,000 a month. If you look at the last column on the right, you will see that for the buyer to be at around that number, he can afford to purchase a $400,000 home when interest rates are at 4.5%.

As we move a column to the left, if the rates rise to 4.75%, the buyer will no longer be able to afford the $400,000 house. Instead, he will be able to afford a $390,000 house. Now let’s jump over to the first column all the way on the left. A buyer who wants to keep his expenses at $2,000 a month would only be able to afford a $360,000 home if the interest rates rose to 5.5%. The difference between being able to afford a $400,000 home and a $360,000 home is the equivalent of 1% of mortgage increase–the amount of interest rate rise that we’ve seen over about the last six months.

What this is showing us is that as mortgage rates rise (which they are doing), buyers will not be able to afford as much house as they once did. They will have to offer less money, some may no longer qualify for the mortgages they want, and things will certainly slow down. Again, this is an example of why a housing bubble isn’t forming (and why now is a good reason to buy!).

To look at this from another angle, one might assume that because interest rates are rising, housing prices are going to tumble and then the market will fall apart. Well, let’s refute those notions by looking here:

August2013-19

Four times over the last thirty years, mortgage interest rates have spiked dramatically. Each spike was more than 1%. So what happened to housing prices during those times? They went up! We can use this historical evidence to say that just because we are seeing interest rates rise does not mean prices are going to go down. Now no one has a crystal ball, so we can’t say with certainty that this will be the case for us here and now. As well, each year of the spikes had various factors affecting the way the market was going (amount of supply of inventory, unemployment rates, where the economy was, etc.). However, we can say that housing prices are not necessarily going to go down. There is no historical evidence to support this.

Well, that’s it for today. I hope you are finding this information useful. See you back tomorrow for more real estate news!

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