Mortgage Rates

Home Buyers are Bond Traders

The fixed income bond market. Likely the most unsexy of all the traders on Wall Street. Also some of the most wildly paid when the bond market is on a roll. It is an area that few casual investors really want to understand. It’s boring. Buying 10 year bonds payable by Chrysler just does’t excite. And more importantly, it confuses any newbie to the debt market.

When interest rates go down, bond prices go up. When interest rates go up, bond prices go down.

Now, why do we as Realtors care? Well, on the most basic level, we care because our 30 Year Fixed Rate mortgages that drive the US housing market are set (at least theoretically) based on federal 10 year treasury notes. But I argue that every home buyer who doesn’t pay cash is gambling in the bond market without really understanding it.

What drives price of a home? Lots of things. Scarcity is top of the list. Inventory is way down across our MSA, and thus, prices are no longer falling, and in many cases even going up.

But the other factor to influence prices is affordability. And affordability is directly impacted by interest rates.

Take a family that today has $100,000 saved to put down on a house. With a 20% downpayment, this qualifies them to purchase a $500,000 home. (Let’s set aside closing costs for the purposes of this argument.) When there was a 4.0% interest rate just a few weeks ago, this would have meant a mortgage payment of $1,909 in Principal and Interest. When the interest rate hits 5.0% — and that will be soon — that same $1,909 no longer affords a mortgage of $400,000. It affords only $355,735. This is an 8.8% reduction in buying power with only a 1% move in interest rates.

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So the question then becomes why are these home buyers bond buyers. Simple. They have a specific return they have decided they need to make an investment. And likely, that return is in the form of specific home specifications. They are looking for 4 bedrooms with a minimum of 3,000 finished square feet in a specific school district. And for months they have been looking, and they have been told by their mortgage lender that they can afford $500,000. As they continue to look for homes, however, they unknowingly are becoming priced out of the market.

But, when they find that dream home, they aren’t going to decide to spend more. They aren’t going to decided to find a cheaper house. They are going to go after this one house, but demand a drop in price commensurate with their new mortgage rate. So, they are looking to cut that $500,000 house to $455,735. Will this happen each and every time? No! Will it sometimes? Depends on the seller and their motivation. But it will happen. And that will bring down comparable sales, and that will bring down the escalating prices.

I said this as the rates were coming down. People don’t buy a house based on sale price. They buy it based on the mortgage price. People didn’t mind prices going up during the interest rate decline because they still paid less, and they felt richer. Well, here comes the reverse of that.

Afordability Index

Originally Published January 31, 2009

I just saw an article from the NY Times that was addressing the affordability of housing across the nation. Click the follow through for the chart and some explanation. Interesting numbers. Could be very positive for the outlook.

Granted, these numbers come from the National Association of Realtors, who I try to quote as little as possible. They are always trying to spin things positively, and I respect their position, but not always impressed with their USAToday quality stats. This chart, however, got my attention for two reasons 1) Because the NY Times found enough interest to put it out there, and 2) Because it is a 35 year look at housing in America.

The NAR has taken a look at Median Income in America and compared it to the income needed to qualify for the Median home price in today’s market. So this looks at home prices, income, and mortgage rates. Back in the 80s when mortgage rates were 18%, the median family had only ~65% of the income needed to buy the median home. From 1989 until the run up in 2003, that number remained between 105% and 120%. As the prices went up in mid part of our current decade, the numbers dipped as low as 100%, but with mortgage rates lower than any time in 50+ years, the Median Family now has nearly 160% of the income necessary to purchase the median home.

This should mean that there is access to more and more first time home buyers to enter the market in the near future. It all relies upon consumer confidence now. Mortgage money is flowing. Wages support the purchase of new homes. The question still falls back on whether people are willing to take the plunge or not.

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