At a recent open house, I spoke with a potential buyer who had an interesting strategy. He planned to wait for interest rates to rise, expecting that would cause home prices to fall further. He reasoned that home prices were driven by affordability and with higher mortgage interest payments buyers would have to buy lower priced homes. He was willing to pay higher interest rates, thinking that would cause the price of the home to be less, which would cause other costs based on the home price to also be less (such as property taxes and closing costs). He planned to be a long-term owner and figured that when interest rates went back down, he could refinance. Then he would have a lower-priced home and a lower interest rate for his home loan.
That approach seemed to make sense, but I thought I’d check historic data to see how it would have worked in the past. Starting with 1975, I compared Freddie Mac’s 30-year fixed rate annual mortgage interest rates to the average price of U.S. houses (including land). Data is from: http://www.freddiemac.com/pmms/pmms30.htm and http://www.economagic.com/em-cgi/data.exe/cenc25/c25m02.
Unfortunately historical data does not support the notion that rising mortgage interest rates cause home prices to fall. Interest rates rose dramatically in the U.S. between 1977 and 1981 from around 9% to over 16%. During that time average U.S. home prices also rose more than 50%, from an average of approximately $54,000 to $83,000. There have been only two periods since 1975 when home prices fell: during the 1989 to 1992 recession and during the current recession beginning in 2007. During both of those times, interest rates also fell. What the data shows is that home prices fall during recessions, they do not fall due to rising interest rates. (It is interesting to see on the Average US Home Price chart that, except for the two bubbles and following corrections, home prices tend to rise at a relatively steady rate.)
There are many articles available about how higher interest rates affect the home price an individual borrower can afford. It is true that higher mortgage rates will reduce the buying power of a particular homebuyer. Also, local real estate markets may not match the U.S. market exactly. However looking at just these two factors, rising interest rates do not appear to result in lower average home prices in the national market.
So, if you are thinking about buying a home and need financing, act now while “interest rates are at historic lows!”
April 28, 2010: Following chart from Business Week added in response to comments.