High Interest Rates Are Good for the Future of the Housing Market
and for Those Buying Houses
today speak of the dangers of allowing interest rates to rise. Some
claim the entire housing market will come to a standstill. Others
speak of the hardship of new buyers managing to buy houses if interest
rates go up. It is no great surprise to any good student of economics
that such fears are groundless.
interest rates would lower prices
first and most important reason that high interest rates would be
good for the housing market is that it would lower the price of
housing to what a normal individual can afford.
of houses are not truly determined by what one is willing to pay
for the house; it is determined by what one is willing to pay per
month for the house. A homebuyer really doesn’t care if his
house costs $100,000 or $1,000,000 – he cares whether his monthly
mortgage payment is $1,200 or $1,300.
the margin, the price of housing is determined by the cost of
borrowing. If interest rates are 5%, the mortgage payment on
a 30-year $100,000 loan would be about $536. If the interest rate
is raised to 10%, then a mortgage payment of $536 would only be
enough for a 30-year loan of about $61,100.
prices would obviously make life very difficult for many people
who own houses and are underwater. However, one of the key insights
of the Austrian Business Cycle is the realization that the quicker
liquidation of bad investments happens, the better. Trying to keep
prices from falling is the worst thing that we could be doing.
With a drastic fall in house prices, many who are currently paying
back their mortgage with hopes of future appreciation will realize
that they made a bad investment and will liquidate. Society will
instead find new, better ways to use scarce resources. At this point,
anything which will help break people out of their paralysis will
prices lower the amount you need for a traditional down payment
of the most difficult steps for a new home buyer is finding or saving
enough money for the initial down payment. It always has been. The
recent goal of the government has been to reduce the percentage
one needs to get a mortgage, which is how many people have managed
to qualify for 3% down payments.
recent student of history knows, these low down payments have led
to many people buying houses they couldn’t really afford. True,
most could at least make the monthly payments when everything went
right… but as soon as anything went wrong, they had no safety net
of saved money to tide them through. Further, with so little initial
equity, it was very easy for many people to have a depreciating
house which led to negative equity. In fact, it was possible to
roll many of the costs of the loan into the mortgage and to start
off with negative equity. When houses didn’t appreciate, and
they ran into any financial hardship, borrowers were trapped.
however, reduce the amount of a traditional down payment without
leading to little or no equity. A $100,000 dollar house would need
a $20,000 down payment to be at 20%. Some banks and regulators are
now even talking about the need for 30% down payments. But what
if the price of houses fell 40%? Then, even with a 30% down payment,
you would only need $12,000 to buy the same house. Further, you
would still have an $80,000 mortgage in the first case and only
a $48,000 mortgage for the second ($52,000 if 20% remains the "standard"
and your down payment was $8,000).
$12,000 is a lot more than the $3,000 you might need now for a down
payment… but that means it will help weed out many of those who
are incapable of paying off a mortgage because they cannot or will
not save for the future. Proof of ability to save may be the most
important indicator of ability to pay back a loan.
interest rates will make it easier to build up that down payment
will the amount needed for a traditional down payment drop, but
higher interest rates will make it easier to save up for the down
payment. Clearly, with higher interest rates, the incentive for
people to save rises. Today, you might get between .5% and .75%
saving money in the bank. It would take a very long time for any
interest from that to help you towards your goal of a down payment.
interest rates from banks were 5% or so, the interest you would
be earning would be enough to actually make a dent.
let’s say you need to save $20,000 for a down payment, and your
budget will allow you to save $4,000.00 a year. With 5% compounding
interest, it would take slightly less than 3.5 years to save up
$20,000. With .5% interest, it might as well take you a full 5 years.
prices make repayment of the mortgage easier
I was growing up, it was not unusual for people to pay extra towards
their mortgage so as to pay it off faster. However, lower prices
with higher interest rates makes this process much more economical.
you are in a situation where you are making the minimum mortgage
payment of $536 a month for one of the two mortgages in section
one, but you bought less house than your maximum budget. You have,
instead, $636 a month to spend.
the $100,000 mortgage situation, you would pay off your home in
21 years and 5 months, and would spend about $62,675 in interest.
the $61,100 mortgage situation, you would pay off your home in 16
years and 4 months, and would spend about $62,257 in interest.
numbers, you could pay off your house over 5 years faster with the
higher interest rate, and you’d even pay less in interest during
prices reduce taxes and insurance payments
most home buyers know, there are more costs in owning a home than
the mortgage payments. The two biggest ones which are regular are
insurance and taxes.
charge taxes based on some calculated percentage of the value of
the home. Thus, a 40% drop in prices would result in a 40% drop
in taxes in many areas as well.2 Similarly,
some states use housing values to determine insurance rates.3
Those states would see a reduction in insurance rates as well.
not only would the cost of the mortgage go down, many of the other
costs will fall as well, which will lead to even smaller mortgage
interest rates will eventually lead to more buyers.
As shown above,
the more interest rates go up, the more prices will fall, both for
the mortgage and for other costs associated with house payments.
As every economist knows, when the cost of something falls, the
quantity demanded will rise, all else being equal. This will bring
new buyers into the market, and new buyers will help us move through
this housing glut.
For the current
homeowner, this may hurt financially, obviously. They will lose
everything they have put into their houses and, depending on their
contracts, still be saddled with some debt. Bringing more buyers
into the market and teaching current home owners that they made
poor decisions will, however, help bring an end to the stagnation
of housing market. Ending this stagnation is in the long-term interest
of every person.
any potential home buyer, higher interest rates are actually much
more helpful than the current low interest rates which artificially
raise the interest rates, as high interest rates will lower prices,
make it easier to pay down payments, and make it easier to pay off
a mortgage at an accelerated rate.
Thus, the great
fear of many politicians of "rising interest rates" is
not the horror story they imply, but the best thing that could happen
to the housing market.
- Note: with
smaller amounts, such as an extra $25 a month, you might pay more
in interest in the second case, but you would still pay it off
- Well… it
should. Given the government bureaucrats, it would probably take
appeals and quite a bit of time to actually happen.
- Others use
the cost of rebuilding the house, no matter its purchase price.
These states might see less of an effect.
January 20, 2011
Sercely [send him mail]
is a personal injury attorney at the M&A
Law Firm in Richardson, Texas. Despite his long hours, he spends
a great deal of his free time reading about and discussing economics
© 2011 by LewRockwell.com. Permission to reprint in whole or in
part is gladly granted, provided full credit is given.