Comments on: Interest Rates Effect on Housing Prices

By: variable rate mortgage – What is the advantage of a fixed rate mortgage over a variable rate mortgage?

Tue, 19 Jan 2010 03:15:49 +0000

[...] Home Mortgage Interest Rates Affect Housing Prices [...]

By: The Financial Blogger » Blog Archive » Financial Ramblings

The Financial Blogger » Blog Archive » Financial Ramblings — Sun, 17 Jan 2010 13:14:09 +0000

[...] Four Pillars discusses the interest effect on house pricing. [...]

By: A Lap Of The Blogs : WhereDoesAllMyMoneyGo.com

A Lap Of The Blogs : WhereDoesAllMyMoneyGo.com — Fri, 15 Jan 2010 03:11:48 +0000

[...] Pillars discusses interest rates and housing prices two years ago, and the writer slightly reconsiders the wording this week. Four Pillars is written by two guys, by [...]

By: jesse

jesse — Tue, 12 Jan 2010 16:24:01 +0000

Low interest rates do have an effect empirically. They have an effect because people are effectively capitalizing a multi-decades investment based upon relatively short-term financing lengths. For a utility company, and apparently a few Bay Street economists as of late, this would seem a rather odd behavior.

Why is this? One reason is that people are expecting income gains faster than inflation as they age. In other words they can absorb higher rates in the future. The flaw is that nobody asks who would be buying when they want to sell. Another reason is that people are assuming low rates are here to stay. If they are, unfortunately, it means deflation.

By: Four Pillars

Four Pillars — Mon, 11 Jan 2010 16:14:33 +0000

I think this strategy is valid for extreme interest rates.

Under “normal” circumstances, if rates go a bit above or below the long term averages then Jess is right – other investments will also change to reduce the effect. Also as far as affordability (which affects demand) – if the interest rates are higher (let’s say 10%) than the longer term average (let’s say 7%) then the interest costs are higher which will reduce demand, but they are not dramatically higher so the demand should still be there. If the rates jump up to 16% then the interest costs are SO much higher that demand will drop – probably to near zero. At this point I think you can get a “deal”.

Same thing if rates are lower. If the rates are say 5% then that makes houses more affordable than the normal 7% but again, not enough to increase demand is a huge way. If the rates drop to 2.5% then this makes such a huge difference in affordability that the demand skyrockets because the number of people who can afford a house (assuming prices stay the same) has increased by a huge amount.

In mathematical terms my theory says that demand for housing is directly related to interest rates (among other things) but not in a linear fashion when interest rates are at extreme values. If there are N people in the housing market when rates are at 10% then there might be 3N people in the market when rates are at 5%. If rates go down to 2% then there might be 10N people looking to buy.

Of course factors like unemployment rates, the economy etc are important but I think when interest rates are at extreme values, then that will over shadow all other factors.

By: Mr. Cheap

Mr. Cheap — Mon, 11 Jan 2010 14:48:31 +0000

jesse: it was quite a while ago when I wrote this (August 2007), and like yourself, I don’t agree with it. The central thesis in this post (which I do still agree with) was that low interest rates leads to more buyers which leads to increased demand which leads to higher prices, all other things being equal. I definitely overstated the correlation (as you say, a number of other factors can come into play) and I agree with you that this would be a naive metric to guide an investment strategy.

By: jesse

jesse — Mon, 11 Jan 2010 04:40:20 +0000

There is some relationship between interest rates and higher prices but any look at the US shows that the effects are second order compared to good old supply and demand. As for buying in cash when interest rates are higher, well, when interest rates are high it’s because other investments are returning high rates too. It’s quite the leap to invest in property during higher interest rate conditions. Any look back to around 1998-2000 when interest rates were higher (and important to note, inflation was low even though rates were high) shows that other investments of similar risk were pulling in 7-8% easy. You would have to forgo the spread between property and these other investments in the name of higher future returns and know that was going to happen. Not as easy as it sounds.

I have doubts we will see markedly higher rates in the near future. It would require a purging of the latest financial crisis losers much faster than what is currently happening. Still, Japan is an example of where property prices can fall despite low mortgage rates.