Why Rising Rates Will Eat Your Home Value

credit myself with the front photošŸ™‚

from Bloomberg:

Rob Braunstein said his search for a three-bedroom home on a quiet street in Needham,Massachusetts, is taking on more urgency as he watches mortgageĀ ratesĀ tick higher. Every increase, he worries, shrinks his budget by boosting monthly payments, he said.

That says everything you need to know about the current real estate market. And if you are considering downsizing your house, you need to do a similar analysis for yourself. What analysis? You need to determine for each 1% increase in mortgage rates, how much more it costs a buyer to buy your house with a mortgage.

Over the past 12 months, the decline in mortgage rates has increased the amount of house that one could buy by 20-30 (THIRTY)%! For this

by 401(k) 2013

reason (and others, like ZIRP causing TINA thinking), house prices have risen strongly – especially in the areas where people desire to live like vibrant cities .

Mark Hanson, a very strong and very thorough critic of the current real estate boom has outlined this affordability boost of super low rates quite eloquently HEREĀ in his blog so I won’t duplicate his fine work. By the way, I often compare Mark with Bill McBride of the well known blog Calculated Risk, who was early in reporting the uptrend in real estate after the crash, in bull bear real estate debates.

But to summarize, if rates were to rise from 3.5% (where the 30 year was a week or so ago before rising above 4% lately) to 5.5%, it will make homes much less affordable. By how much?

Home Affordability Example*

In these examples I will assume $600/mo for taxes and insurance

A person with ability to pay $3,000/mo Ā for a home at 3.5% can afford a mortgage ~ $525,000Ā 

A person with ability to pay $3,000/mo for a home at 5.5% can afford a mortgage ~ $425,000

*figures are rounded and $3,000 includes an assumed $600/mo for taxes and insurance

With that said, if you plan to sell your home, whether it’s because you are downsizing in retirement or simply moving, you need to decide using data like this. First off, though, you must make an assumption. Yes you do and we all make assumptions each day so don’t argue with me. You have to make an assumption based on your view of the interest rate market. And here it is:

Do you think mortgage rates will rise, fall or stay flat up until the time you sell?

How you answer this has a HUGE impact on your plans. Because if you think rates will rise, and you live in a town that typically attracts mortgage buyers (the non-super wealthy), then the price of your home could fall significantly if rates were to rise. As in the example above (if that were hypothetically you) a Ā buyer could afford $100k less to buy your home – and believe me, all buyers using mortgages will be affected.

However, if you think rates will stay relatively flat or even fall, then your home value may continue to appreciate. You also have to take into account today’s demographics. Young buyers are buying before they are married ,and are preferring to live in or close to vibrant cities; furthermore, simplicity of living is key. Therefore, if you live in a 5 bedroom house in a mundane middle class suburb, you might be in trouble because young buyers just don’t want those in enough numbers to buy what those over 60 will be selling in the coming years (that’s my opinion).

On the other hand, Ā if you own a nice home in a vibrant area (say Harvard Square in Cambridge, MA, SOBE in SF for examples that I know well), you may see increased demand (SF rents and prices up 30%+ YoY!).

My opinion in a nutshell is that very low priced properties (cheap condos for example) will be lightly affected by a 2% rise in rates. Multimillion dollar homes won’t be affected as much either. But I think the McMansions, the houses where a 2 income family commits a decent chunk of their earnings to a fat mortgage payment, will see a more significant hit to values if rates were to rise. Reasons should be obvious.

Stock Market & Bond Market Dynamics

Also note, as I write this, the stock market is weak. And unlike in the past, investors are not swapping into treasury bonds today as they used to (which would knock rates down). The market is expecting some rate increases. Therefore, it seems the only hope for lower rates is even more significant buying from the Fed. But note, we have seen in Japan that hyperdrive amounts of central bank spending creates serious market volatility.

At this moment it might be time to lower risk and maybe add to some precious metal positions. “Cash” has become too manipulated and the potential side effects are enormous.

I just want to take a final note to congratulate Mr Bernanke and the FOMC – they have boosted the asset values of the wealthy – their real estate and their stocks – by 20-30% in one year while also blowing out savers in the bank by giving them 0% on their savings accounts. All while creating no new jobs (not sure how they would anyway but that’s their justification). Congratulations! Or it’s better said by the always great Marc Faber:

ā€œThe fallacy of monetary policy in the U.S. is to believe this money will go to the man on the street. It won’t.Ā It goes to the Mayfair economy of the well-to-do people and boosts asset prices of Warholsā€¦Very happy. Very good for the Fed.Ā Congratulations, Mr. Bernanke.Ā Iā€™m happy. My asset values go up but as a responsible citizen I have to say theĀ monetary policies of the U.S. will destroy the world.ā€