Interest Rates Creep Back into the Minds of Consumers: A New Look at an Old Headline

Posted in National Housing Market | Posted on 06-28-2013 | Written by Madison Inselmann

Ben Bernanke moved markets with his comments after the recent Federal Open Market Committee meeting when hinting that the Federal Reserve will/may/could/should back off of its $85 billion a month bond buying program.  As a result, the stock gyrated wildly like an 7.0 Richter Scale earthquake printout driving a notable jump in interest rates.   Similar to the violence of being startled awake from a deep sleep, after a four year monetary policy drumbeat…the market had a mild heart attack as it was shocked from it’s comfort zone.

Of course things have normalized, to a certain degree, as they typically do after immediate reactions to economic news, but it caused me to consider what impact interest rates will have on the home buying market when/if/should they begin to trend upward.  Shoot, I spoke to a new home salesperson that shared that a buyer delayed the closing because they wanted to wait for rates to drop back down.  I was confounded by this as the difference between 3.4% and 3.9% (approximately $56 per month on a $200,000 loan) pales in comparison to the fact that we’ve been spoiled below 4% for so long and that our party may be coming to an end.

As market analysts, we tend to believe that metrics seek their trend.  For the last 20 years, the average rate on a 30-year mortgage has been 6.5%, two percentage points higher than the rate today (June 27th, 2013).  Assuming the Federal Reserve will smoothly release rates once they end their bond program, we looked how mortgage qualification reacts to rates being at 3.5%, 5%, and 6.5%.  In the graphic below we hold constant the monthly principal and interest payment ($898) assuming that consumers (if they’re like me at a farmer’s market) look to spend as much as they can.

Figure 1: Home Buyer Purchasing Power as Interest Rates Rise

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Considering the number of regional housing recoveries occurring throughout the nation, the differences between a $200,000 home and a $170,000 or even a $140,000 home can be quite stark. It could be the difference in location, school district, and community amenities.  It very well could be the difference between being able to buy  a new home or a resale home, as is the case here locally in Austin where new home construction priced under $200,000 has seen a sharp decline as tight lot supplies push prices upward.  In fact, the chart below shows the drop in new home absorption by price point, again assuming buyers are shopping for as much as they can qualify for at the moment.  For the market between $200,000 and $500,000, a rise from 3.5% to 5% equates to a 24% decline in absorption.

Figure 2: Calculated New Home Absorption as Interest Rates Rise – Austin, TX

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Red line represents Metrostudy’s 1Q-13 Annual Closings in the Austin Market when the average rate = 3.5%.

After his initial statement, Bernanke has backed off his speculation of the Fed ending the bond buying program in the near term.  Nevertheless, everyone else was (over-)reacting to the news so I thought I’d join the fray and use this as a segue to try and make the effect of interest rates more tangible.  You will go crazy trying to guess what interest rates will do from one day to the next.  What will happen once they do rise is a little easier to decipher.


Comments (2)

The changing environment for interests rates is very interesting to watch when trying to forecast future home prices. I invest in the PHX metro. area and prices have been surging here for the past year. Inventory is low (around 2 months supply) and pricing for new homes has been increasing because of the lack of available inventory and the increase in building costs (labor, land). Yet, now with the increase in rates will the aggressive price increases from new home builders continue or will we see a slowing of the pace? To be determined. The conventional wisdom is we will see a slowing of price increases, yet with builders holding back on supply they may still have the upper hand so it will be interesting to see how this plays out.

Steve, it sounds like supply and demand is back to driving the Phoenix markets. After years of depressed new home construction, many of the recovery markets are now feeling the effects of limited housing stock. What I’ve found encouraging in the last few weeks here locally in Austin is the acknowledgement by builders of the need to price future land deals at expected future housing market prices instead of getting caught up in a “hurry hurry, buy now” scenario as land is tight and pricey. This bodes well for the home buyers in 2015 and 2016 who may be facing a higher interest rate relative today.