Do Mortgage Interest Rates Drive the Housing Market?

Do Mortgage Interest Rates Drive the Housing Market?

For those in their late twenties and thirties, a soft housing market is a new concept. For baby boomers this is familiar territory. In the last few years when interest rates were low and houses were cheap, newbie adults were diving in to home ownership head first.

The leap proved to be a great financial move and the investment more than doubled in some housing markets. Almost overnight, that fabulous investment became a huge liability for many. How did that happen?

The housing market is cyclical. Like all aspects of the economy, supply and demand play a huge part in the housing market. The delicate balance of maintaining the same number of houses as people out there to buy them is impossible with so many factors influencing the market. Some factors snowball on others spiraling the housing market in a certain direction.

Interest rates play an important role in housing prices. When interest rates go up, then the potential mortgage payment goes up for the very same house that cost 500 dollars less before the increase in the interest rate. Consequently, people can’t afford to buy the house since their salary probably didn’t go up to match the interest rate. Therefore, in order to find a buyer, sellers have to lower the price of their houses in order to sell them.

When the interest rates were low, people were scrambling to buy houses. There were not enough houses on the market for the number of people wanting to buy them. Builders began to salivate at the potential earnings and started building houses without potential buyers backing them. The demand drove the supply.

Lenders began offering many creative loans to people in order to take advantage of the housing market and help buyers get as much house as possible. These creative loans included adjustable rate mortgages and interest only mortgages.

An adjustable rate mortgage maintains a lower interest rate for a set period of time, which could be one year, three years, five years or even seven years. This allows buyers to pay less interest and put more of their money toward the actual price of the house. The problem comes when the time is up and the mortgage then adjusts to match the current interest rate.

An interest only mortgage requires that only the interest on the mortgage be paid. The principal remains the same. This made for a really cheap mortgage on a really expensive house. There were three problems with the creative loans being offered. First of all it helped people get more house than they could actually afford. The second problem was when the housing market dropped, home values went down. People actually owed more on their loan than their house was worth which of course they could not afford to begin with. The final straw came when the adjustment was made on the interest rate and their mortgage payment went up causing them to be unable to make their mortgage payments and risk foreclosure.

The economy, unemployment and household income are other factors that determine housing prices for obvious reasons. Layoffs and cut backs in the car industry related to higher gas prices have caused many people to scramble to pay their mortgages. Money to fill the gas tank with gasoline costing more than four dollars a gallon to get to the job that pays the mortgage has to come from somewhere.

By  John Hester

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