Wednesday, April 26, 2006

Housing Recap - What Does a 1% jump in Mortgage Rates Mean to You?

A ton of data hit the markets this week on housing and the headline numbers made many in the "There's No Bubble" crowd cheer. There was a bit of a bounce from Feb's seasonal lows into March, but trends are not made on month to month data, but rather year over year. March existing home sales and new home sales both came in below 2005's numbers and more importantly the pricing numbers were off sharply as both the median and the average prices fell.

Today the average 30 yr fixed rate mortgage sits at about 6.5% up from 5.5% in July 2005. While this is a meaningful jump, we are still far below the 8.5% rates we saw in 2000 just 6 short years ago.

I think it's important to see what a 1% jump in interest rates does to housing affordability. Let's do some scenario analysis -

Assume that a buyer buys a home priced at the national median of $220k and puts 20% down - I know, I know, stop laughing "no one puts 20% down anymore" - just bear with me.

This $174k mortgage at 5.5% in July 2005 produced a monthly payment of just $991 and total interest over the life of the loan of $183k. Today that same loan costs $1,100/mth and produces total interest costs of $223k over the life of the loan. In order to maintain the original $991 payment at today's interest rates you would only be able to afford a $156k loan - roughly a 10% decline in the price. Not a huge swing but clearly indicative of what's happened in the market in the last 9 mths.

Where this exercise can really get entertaining is with large mortgages. Let's say someone pays $625k for a home and again (humor me) puts 20% down yielding a $500k mortgage.

At 5.5%, the monthly payment for this mortgage is $2, 850.
At 6.5%, the monthly payment for this mortgage is $3,170 ($320 increase)
At 8.25% - just 1.75% from current rates - the payment is $3,758 (a $908 increase/mth).

If interest rates were to reach 8.25% again, the price of our example home would have to be lowered $474k (again with 20% down) to equal the original monthly mortgage of $2,850. If our original buyer at $625 in July 2005, has to sell at $474, they will
  • Have lost their entire $125k down payment
  • Have zero equity in the home
  • Have to likely write a check to terminate the balance of the loan for $20k or so.
Welcome to 1991 all over again.

Ok, so I know there are not a lot of $625k homes for sale in the North Country - 14 by my count - but the impacts are meaningful if this plays out downstate or across the US. A weakening housing sector will hurt job growth, hamper tax receipts, negatively affect state funding for schools and possibly impact Federal spending on military bases like our lifeblood - Ft. Drum.

In 1997, I was beating the drum that outsourcing was coming. It took 7 years for everyone to catch on and by the time we did we were all calling Frank in Bangladesh to fix our PC. I may be early on this call, but the impact of interest rates on housing and ultimately our entire economy could be dire.

No comments: