Thursday, December 30, 2010

Rising Rates: Simple Economics

The following chart shows the recent rise in mortgage rates.


This spells disaster for housing which was recently described by Robert Shiller as a market "where optimism is fading fast."

The time to purchase a home is when interest rates are high.  (If you are interested in making money on your home.)  The reason is because as interest rates fall it lowers monthly payments and allows new buyers into the market or current buyers to purchase at higher prices with their current income level.

Higher demand (more buyers) = higher prices if supply stayes equal.

The exact opposite is true for purchasing when interest rates are low.  (Unless you are interested in losing money on the home you purchase) 

Lower demand (less buyers) = lower prices if supply stayes equal.

The most recent rise in mortgage rates that can be viewed in the chart above pushed the monthly cost of a $300,000 mortgage from $1,462 to $1,585 per month.

This discussion does not look at the other side of the equation, supply, which as I've discussed previously is rising rapidly due to the shadow inventory of foreclosures beginning to enter the market.  Here is the full economic model for 2011 completed:

Lower demand (less buyers due to mortgage qualifications and unemployment) +

Supply growth (new inventory and months supply growing throughout 2011) =

Prices Falling

I only wanted to review this discussion because a realtor mentioned to my parents over Christmas break that they had buyers rushing into the market because interest rates were rising and they wanted to lock in at low rates.  This is the exact opposite way potential home buyers should be making a buying decision.

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