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House prices and the Fed
What will happen to housing prices now that interest rates are rising?
July 2, 2004: 1:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

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NEW YORK (CNN/Money) - With interest rates expected to rise, what will happen to housing prices?

-- Joe M., Philadelphia, Penna.

I don't think there's much doubt that rising interest rates are not a plus for home prices. The reason is simple: when mortgage rates rise, the monthly payment necessary to finance a house of a given price also goes up, which means houses become less affordable.

Let's say, for example, someone is buying a $250,000 house by making a $50,000 down payment and taking out a $200,000 30-year fixed rate mortgage. If the buyer gets that mortgage with a 5 percent interest rate, the monthly principal and interest payment would be $1,074. The payment for that same mortgage at a 6 percent rate would be $1,199.

Clearly, the higher income needed will knock some potential buyers out of the market, reducing demand for the house. As this happens with millions of homes around the country, it's likely that prices won't climb as quickly as they would when rates were lower.

The real world effect can be complicated

In the real world things don't always work quite so neatly. For one thing, when rates first begin to rise, demand for houses can actually increase as procrastinators begin moving to lock in deals. Indeed, despite rising mortgage rates this year, the Commerce Department reported last week that sales of new homes rose almost 15 percent in May.

It's also true that as rates for fixed-rate mortgages begin to climb, home buyers will often turn to adjustable rate loans, many of which have lower initial "teaser" rates. So the demand for houses might not decline as much you would think as rates begin to rise.

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This is especially true at times like today when, despite recent rate increases, mortgage rates still remain at relatively attractive levels.

It's also important to remember that even if rising rates do depress the demand for houses, that doesn't necessarily mean house prices will fall.

Indeed, the yield for 10-year Treasury bonds -- the rate that fixed-rate mortgages tend to track -- has climbed from as low as 3.2 percent in June, 2003 to more than 4.8 percent in early June. Despite that rise, however, the demand for houses held up pretty well and house prices overall have risen during that time.

Price and demand

That said, however, the higher rates go, the more likely they are to dampen both demand for homes as well as price appreciation. Again, that doesn't mean prices will fall. Outright declines in house prices aren't all that common.

And when they do occur, they tend to be in markets where prices were bid into the stratosphere due to a combination of frenzied demand, a feeling on the part of buyers that they had to buy now lest houses become totally unaffordable in the future and, often, some sort of a restriction on the supply of new houses -- lack of developable land, zoning restrictions, etc.

To sum up, yes, I think the specter of rising rates should make home buyers more cautious about buying a house, particularly if the house is in a neighborhood that's seen prices zoom upward the past few years. Still, I don't think it should automatically put the kibosh on someone's plans to buy, although I'd be more wary of buying now if I thought there was a good chance I wouldn't stay in the house at least seven years.

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For more on this topic, as well as some links to sites that might give you more insight into the relationship between house prices and interest rates, I suggest you check out a column on this subject that ran earlier this year on CNN/Money.

And while you're at it, you might as well check out our Rate Search section for the best deals of mortgages of all types and take a look at our Real Estate section to keep up with what's going on in the housing market, rising rates or no.


Walter Updegrave is a senior editor at MONEY Magazine and is the author of "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World." He also answers viewers' questions on CNNfn's Money & Markets at 4:40 PM on Mondays.  Top of page




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