Postponing a Home Purchase Waiting for Home Values to Decline Further May Price You Out of the Market
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U.S. home prices have declined across the nation in the past year—albeit at varying levels. Latest national price declines (and again I invoke the TINSTAANREM Clause — There Is No Such Thing As A National Real Estate Market) range from as little as 4.5 percent (Dallas, Texas) on a year-over-year basis in February to as great as 35.2 percent (Phoenix, AZ) according to S&P’s Case-Shiller Home Price Indices.
It is the anticipation by many prospective buyers for further home price erosion that keeps them on the sidelines and from participating in homeownership despite the lowest interest rates since Freddie Mac commenced the statistical series in 1971.
While further price declines may be realized, I believe the likelihood of rising interest rates makes purchasing now a better option than waiting for further potential value declines. Simply stated, there is a greater possibility of interest rate increases than potential value declines. Even with the price decline, the interest rate increase may result in the buyer no longer being able to qualify for a loan on a home they wish to purchase for which they qualify today. Despite facing a potential in declining home values, now may be a better time to buy.
To make the comparison simple, let’s assume a loan amount today of $100,000 with a 30-year fixed-rate residential loan at 5 percent. Nationwide at the time of this writing, the average 30-year rate was 4.85 percent per Freddie Mac. Fannie Mae forecasts an average rate in all of 2009 of 5.13 percent. So the 5 percent is a reasonable assumption.
The following table shows the monthly payment for each loan amount and interest rate. A buyer today at 5 percent interest borrowing $100,000 has a monthly principle and interest payment of $536.82. If prices decline 5 percent (and the loan amount does also) and interest rates rise just ½ of 1 percent, then the monthly payment remains the same ($539.40).
So if rates go up just 1 percent to 6 percent per year, then prices must drop at least 10 percent for that same buyer to qualify for the same monthly payment. A 1.5 percent increase in rates to 6.5 percent requires a 15 percent price decline, and a 2 percent increase necessitates a 20 percent price decline to qualify. Note: This 1 percent interest rate change to a 10 percent price change is only true when interest rates are 5 percent as they are today.
Admittedly, at the same loan-to-value ratio, as prices decline so does the down payment. Since, however, many buyers select the price range of homes they consider buying based on their monthly payment potential, rising rates may force future buyers into less expensive homes and hence properties they find less desirable.
Why do I expect rates to increase in the future more than price declines? First examine the Case-Shiller Table above. Aggregate 20-city prices have already declined 29.1 percent since peaking in July 2006. I believe much of the price decline has already taken place. And why do I anticipate rate increases? There are several reasons. Interest rates are the lowest in recorded history. But perhaps most important is the record deficit spending by Congress and the Administration and the expectation for that to continue. Borrowing a couple of trillion dollars this year coupled with a now-projected decade of deficits of at least $1 trillion per year sets the stage for a weakened dollar and corresponding rising interest rates. In plain speak—the massive deficit spending has a high potential to drive up inflation and hence interest rates. A topic to be discussed in a future blog.
If you agree with me, quote me. “Postponing a home purchase waiting for home prices to decline further may price you out of the market.” Ted C. Jones, PhD, Senior Vice President—Chief Economist, Stewart Title Guaranty Company.
Agree or disagree, let’s have some comments.