Housing Prices and Interest Rates: Do the Math

I wasn't trying to start an argument. Honest. But that's exactly what I did.

In my last column "If You Don't Buy a House Now, You're Stupid or Broke", I suggested that prospective home buyers should pay more attention to today's historically low interest rates than to the price of the home. My reasoning, I thought, was obvious.

Every quarter-point change in interest rates is equivalent to approximately $6,000 for each $100,000 borrowed over the course of a 30-year fixed-rate mortgage. So, if you have decided to put down $40,000 and borrow $200,000 to help pay the typical nationwide home price, but you wait until mortgage rates rise one full point, you will end up paying an additional $48,000 over the course of your loan. Borrow $500,000, as some people on either coast do, and you are out an extra $120,000.

My conclusion? If you are thinking of buying or trading up, and you have a good job and good credit, act now.

Readers Bite Back

Much to my surprise, this evoked some very passionate dialogue.

While scores of comments showed I'm not alone in my analysis, there were at least an equal number who vehemently disagreed.

The most popular reader critique, articulated in many creative and, er, "expressive" ways, argues that when interest rates eventually rise, home prices will drop further, and that decline will more than eliminate the advantage of the current low interest rates.

A reader named Craig succinctly summed up this opinion, stating: "This article is retarded. There's an inverse relationship between interest rates and housing prices (rates go up, prices will go down)." (I added the words "you dope," to the end of Craig's comments as I read them, but you don't have to.)

Jim agreed and added: "I would rather buy with cash at high interest rates and refinance when they drop."

Paul seemed to combine both Craig and Jim's assumptions, noting: "The best option…is to buy a house when rates are high. As rates fall, your house goes up in value and you refinance and your payment goes down. For proof of that, look at the last 15 years in the housing market."

Reading the Data

O.K., I thought, maybe the people questioning my logic (and sanity) were right. Maybe prices will go down further as interest rates rise. All I needed to do was look at historical trends to find out.

The analysis took about two minutes. I searched the internet for historical home prices and found that average existing home sale prices steadily increased from 1970 through 2006 (the peak before the housing bubble burst). (Click here if you want to double-check my work.)

I even found a nice graph (see above) that converts the data and illustrates the nominal home prices as well as inflation-adjusted pricing, which showed the same thing.

When comparing this data to the interest rate data I provided in an earlier article, I found that housing prices did not fall in the years when interest rates were rising. In fact, housing prices generally rose when interest rates climbed. When reviewing the numbers adjusted for inflation, housing prices still rose when interest rates made their steepest climbs and even fell when interest rates retracted. The most obvious examples were the years from 1975 through 1983.

Therefore, history indicates that the argument posed by Jim, Craig, Paul, and the others is fatally flawed. The facts reveal quite the opposite.

a lifetime low in interest rates

Many of the same dissenters, in addition to assuming housing prices will drop as interest rates rise, argued that people should then purchase homes with cash and then refinance when interest rates eventually drop again.

I love that one!

Who is buying homes for all cash today? When do you think 30-year interest rates are going to come back down to 5% again? Certainly not in my lifetime, and I doubt it will happen in my kids' lifetimes.

I know I've said this many times over the last several months, but given the nonsense I keep hearing from the naysayers, I can't help but repeat it again.

Housing prices have dropped an enormous amount and have seemingly stabilized. Interest rates are as low as any of us have ever seen them and likely are as low as any of us will see in our remaining lifetimes. Housing inventories are above historical averages, thus selection is high, but I want to point out that inventory has started to decline.

Even those in the business of buying and selling foreclosed properties will tell you that while foreclosures are still coming, the selection is waning and the opportunities are becoming less attractive. Finally, with the soon-to-expire tax credits, the government is paying you to buy a house. People continue to complain that it's not fair that the federal government is bailing out the banks and not helping the average Joe. Well, that's just not true. Low interest rates and tax credits help the average Joe.

If you are employed with a good job, have decent credit, believe that home ownership is still a fundamental precept of the American dream, and either don't own a home or don't own the home you want, now is the time to take your head out of the sand and start doing your home work. If you don't, you will look back at having missed the opportunity of a lifetime. (And please, keep those comments coming.)

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