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.

Quick and Short Run

Originally Published January 8, 2009

In a three month time, mortgage rates went from 6.47% down to 5.03%. This is the lowest rate in decades. The goal was the get the financial markets running, and it did. Unfortunately, it did not do anything for the purchase market, but rather got the refinance market off and running. In fact, the mortgage market saw the most applications taken in over 5 years. But it was short lived, and this week as rates inched up to 5.07%, applications dropped over 8%. People are sitting back and waiting for the big foot to drop. They want rates below 5.000%, and they are going to wait for them. The prospect of 4.75% rates are keeping people from taking advantage of the best mortgage environment this country has ever seen. For a quarter million dollar mortgage, this represents less than a $50 difference in payments, or 3% change. Interesting times.

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