There’s been some very good commentary in recent days about whether a reduction in mortgage interest rates might help boost house prices. Counterintuitively, the answer seems to be that there’s a good chance it won’t:
A 2006 study of mortgage rates and New York City housing prices going back to 1975 by Lucas Finco of Quadlet Consulting found no correlation between lower mortgage rates and higher housing prices, or vice versa. "The relationship between mortgage rates and home prices is pretty obscure," says Jack Guttentag, a professor emeritus of finance at the Wharton School of Business.
James Hamilton, a professor of economics at the University of California, San Diego, says he used to think that lower mortgage rates were responsible for rising home sales in the first half of this decade, and for that reason he projected home prices would rebound in 2007. He now says rising home sales were the result of deterioration of lending standards and not lower mortgage rates. "I was wrong. The real story with home sales has to do with the availability of credit," says Hamilton. "And credit is tight now."
Calculated Risk gets a bit wonkier: yes, he says, lower mortgage rates help tilt the balance of the rent vs buy calculation. But:
Landlords, already struggling with high vacancy rates and falling rents, would probably lower their rents further and make the rent vs. buy decision more difficult again. So lower interest rates might not boost demand very much, it might just lead to lower rents.
My feeling is that lower mortgage rates do feed through into higher prices in an up market. It wasn’t all that long ago that we were all bombarded with the advice to "buy the biggest and most expensive house you can afford" — since houses always and everywhere rise in value, that’s just a way of maximizing your net worth. Clearly, the lower that mortgage rates go, the more house can be bought with a monthly dollar of mortgage payment, and during the bubble, people were putting every last penny they could scrounge into their mortgage payments.
Now, however, things have changed. For all that a few brave souls are poking their heads above the parapet and wondering whether it’s a good time to buy, there has been a dawning realization that maybe a strategy of deliberately maximizing your mortgage payments might have a certain amount of downside. In other words, we’ve gone from:
- How much money will the bank lend me?
- Now what can I buy with that?
- Where do I want to live?
- Can I afford it?
In this new world, lower mortgage rates might just allow people to buy property which was formerly just out of their grasp. But that’s a marginal effect, and lower prices would be more effective at that anyway. If people stop buying houses on the outer edge of affordability, then I see very little way in which lower mortgage rates are going to feed into higher house prices.