December 22, 2010

If Interest Rates go Up then Will House Prices Go Down?

Right now mortgage rates are very low.   30 year fixed mortgages are around 4.25% give or take.   This allows people to buy more house than they could if the mortgage interest were higher.   Lets say for example that you can afford a payment of $1200 a month.   At 4.25% rate you'd be able to finance a loan of about $244,000.   But if interest rates went up 1% to 5.25% then you'd only be able to get a $217,000.    So logically we could imagine that people are buying more and paying more for houses now than if the rates were higher.

If interest rates go up then we might assume that home prices may fall as a result.   Seems pretty logical.  

But is that what happens normally?   Has it happened in the past?   How much impact do mortgage interest rate changes actually have on home prices?

I figured I'd look at old data and compare the two numbers to see how they correlate.  The theory is that if interest rates go up then home prices will go down.   If that is true in reality then we should be able to see a direct and repeated inverse relationship between the two numbers.

The home values are using the S&P / Case Shiller index.  I got the mortgage rates from the Federal Reserve FRED database.   Here is a graph showing the home price index versus the 30 year fixed mortgage rate from 1987 to 2010:

I do not see any real relationship between those two lines.   The interest rates bounce up and down at times and the home price values don't change much and other times interest and home prices go up at the same time.   If there were a clear relationship between the interest and the prices then you should see a clear trend.

But lets zoom in to a few years and look at the numbers a little closer.  Here I show the trend between interest and home prices from 1992 to 1996. 

Now there seems to be more of a correlation.   But oddly they seem to be going in the same direction.   Interest rates go down and home prices go down too.  It is possible that this is simply a seasonal pattern, but I'm not sure.  

Bottom Line : I don't see any reliable or visible relationship between changes in the mortgage interest rates and home prices.

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