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November 23rd, 2012

How low mortgage rates help improve home prices

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The post below first appeared on U.S. News & World Report’s Home Front blog on Nov. 20. A special thanks to Meg Handley and the entire Home Front team:

Mortgage and down paymentYou might have heard rumblings about home prices rising again, even posting double-digit increases in some metropolitan areas. But what you might not know is that the Federal Reserve actually has a hand in the helping the nation’s real estate market recover.

The Fed has repeatedly committed to keeping long-term interest rates low, and based on minutes from its most recent meeting, there’s some talk that the nation’s central bank could unveil yet another Treasury-buying plan to replace a program expiring at the end of this year. More demand for treasuries fueled by a Fed bond-buying program drives yields on those bonds lower. Because mortgage rates are indexed against Treasury yields, a drop in yields for T-bills means lower interest rates on mortgages.

Low rates, higher prices

But how does that help home prices, which remain about 30 percent off their 2006 peak?

If you’re a homebuyer, lower mortgage rates open up more expensive properties to your budget—about 20 percent more expensive than you might be able to buy if rates were at, for instance, 5 percent. And since home price measures are based on homes actually sold and the ability to buy more expensive homes is enhanced by lower rates, home prices begin to rise.

Here’s how it works: Using “qualification ratios,” lenders determine how much of a borrower’s monthly gross income can be used to support a monthly mortgage payment. For most borrowers, the ratio is 28 percent.

Lower rates, lower income

Let’s say your monthly gross income is $3,000—28 percent of that is $840 per month. With a 30-year term and a 5 percent interest rate, that $840 per month will allow you to borrow about $156,000. However, at 3.5 percent interest, that same $840 per month will allow you to borrow about $187,000. (These amounts are reduced when taxes, insurance, and other debts are taken into account.)

Mortgage calculator: Calculate your monthly mortgage payment

Lower rates also lower the income needed to buy that $156,000 home, too. Instead of $840 per month at a 5 percent rate, the 3.5 percent rate only carries a $701 monthly payment and the borrower only needs a $2,500 per month income to qualify for it. This brings more potential homebuyers into the market, increasing demand. That fosters price increases as sellers, seeing more people interested in their property, become more resistant about accepting low-price offers.

While there are of course other costs and issues associated with homeownership which might not exist when you rent, including maintenance, a down payment, getting a mortgage, closing costs and more, lower monthly mortgage “carrying costs” can make buying a home very competitive with renting.

This is especially true in markets where rents have been increasing quickly. If you are a renter and find yourself in such a market, study your local real estate market and consider buying a home when your lease comes up for renewal. If you plan on buying a home in the next few years and you decide to wait, the combination of interest rates and price climate (”affordability”) might not be as favorable.

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2 Responses to “How low mortgage rates help improve home prices”

  1. Ben Koshkin Says: November 24th, 2012 at 4:22 am

    Excellent written Tim. Mortgage rates really improve home prices. Thanks a lot!

    Ben Koshkin
    Land development

  2. Jason Says: November 25th, 2012 at 10:07 pm

    Wouldn’t the other side of that be that one can buy more house but taxes will be a killer because of the more expensive property? That was always a worry when some foreclosed home came to market at lower rates, that at some point those same homes will be assessed higher later and suddenly home buyers are having problems paying for their homes again.

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About the HSH Blog

HSH.com's daily blog focuses on the latest developments in the mortgage and housing markets. Our mission is to relate how changes in mortgage rates and housing policy, as well as the latest financial news, impacts consumers, homebuyers and industry insiders alike. Our 30-plus years of experience in the mortgage industry gives us an edge as we break down the latest changes in an ever-changing market.

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Tim Manni

Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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