Mortgage Rates and Home Prices

Over the holiday weekend I had a nice conversation with a friend about interest rates and home prices. We speculated about what might happen to home prices if rates go up in the future, but neither of us could point to evidence that a relationship between the two variables actually exists. Afterwords, I decided to look for real data to understand the statistical relationship between rates and home prices. From a historical perspective, do rising or falling interest rates have an impact on home prices?

Get the Data

For historical home price data I went to the most widely recognized gauge of U.S. home prices, the S&P/Case-Shiller U.S. National Home Price Index, and found a data set for the monthly value of the index dating back to 1975. The St. Louis Fed publishes the raw Case-Shiller home price index data and makes it easy to download. For historical mortgage rate data, I found that Freddie Mac provides historic tables of monthly mortgage rates dating back to 1971, and their site links to the raw data in spreadsheets. I downloaded the history table for the 30 Year Fixed-Rate Mortgage and focused on 1975 to the present to line up the dates in the two data sets.

Formulate a Question

Before getting into the data, I asked a few basic questions: do rates affect home prices? If so, how? More specifically, are the two variables correlated in any way? What can we expect from home prices if rates go up?

Explore the Data

To get a better sense for the range of values in the data and where we are today, I looked for the mean, min, max, and current values as well as the years in which the top and bottom of the range of values in both variables occurred:

Interest Rates

From January 1975 to August 2016:

Mean	8.3
Min	3.3 (2012)
Max	18.4 (1981)
Current	3.4
Standard Deviation	3.2

Home Prices

From January 1975 to August 2016:

Mean	97.5
Min	25.2 (1975)
Max	184.6 (2006)
Current	184.4
Standard Deviation	48.3

The range of values in the data shows that the fixed-rate on a 30 year mortgage is almost as low today as it was at the very bottom of it’s recorded history in 2012. Also, the Case-Shiller Home Price Index is currently just .2 away from it’s highest point ever recorded since 1975, very close to the peak of the housing bubble in 2006. So we are near historical lows for rates and historical highs for prices. Or, as a statistician might put it: we are looking at the tail ends of the distribution.

Rates are currently one and a half standard deviations below the mean, while the Home Price Index is nearly two standard deviations above the mean.

Prepare the Data

I merged the two data sets into a single, 3-column table that has a row for every month of the year from January 1975 to August 2016:

D	X	Y
1/1/1975	9.43	25.25
2/1/1975	9.10	25.29
3/1/1975	8.89	25.36
...
6/1/2016	3.57	182.19
7/1/2016	3.44	183.43
8/1/2016	3.44	184.42

Where D is a date, X is the rate, and Y is the housing index value.

Regression Analysis

To see if rates affect prices, we plot Y, the housing index value, as a dependent variable and X, the rate, as an independent variable. Since we think X has an impact on Y, we can use R to do a simple linear regression analysis on the data.

In the plot, a regression line, the best-fitting line that minimizes the sum of the squares of the vertical distances from each data point to the line, explains the relationship between the two variables. It slopes down. When y-axis values are high, x-axis values tend to be low; when y-axis values are very low, x-axis values are very high. Clearly, there is a strong negative correlation between the two variables and the data visualization makes this plain to see. A strong negative correlation only suggests that high values for X are associated with low values for Y. This is demonstrated by 41 years of data analyzed here. But a strong negative correlation does not imply that X causes Y. In other words, a low fixed rate interest on a 30 year mortgage does not cause home prices to go up. That being said, it is not unreasonable to anticipate lower home prices as interest rates go up because, simply put, the regression line slopes down.

One area of the scatter-plot to highlight is the data point that is closest to the upper left-hand corner of the plot, in which prices are at all-time historical highs and rates are at all-time historical lows. This point is from 08/01/2016.

Will Home Prices Continue To Rise?

During the past several months, while selling a property and looking for a new one, my perspective on the housing market has changed.

Now deeply involved in the home buying process, I can't help but worry about the current enthusiasm around recent home price increases. This is my attempt to dampen this unfounded optimism with a little caution.

What I see as some basic facts:

Factors that are contributing to current home price increases:

• Low interest rates
• FHA lending
• Low inventory

Factors that could contribute to home price declines:

• Higher inventory
• Traditional lending standards
• Unemployment
• Salary stagnation
• Student Loan debt

Basic Questions

What is going to sustain home price increases? Do interest rates stay low or decrease even further in the next 3-5 years? The Fed stated that rates will stay low until late 2014. Low rates are not indefinite and run a good chance of being higher in 2015.

Do FHA loans provide a solid foundation for the full housing recovery everyone wants, and should FHA be the way forward? Not really.

Will low inventory levels stay low? If foreclosure activity picks up again, and lenders begin to clamp down on delinquent borrowers, a much needed flow of distressed property will come onto the market and inventory levels will rise.

From this standpoint, it seems that the factors that are contributing to the recent home price increases are weak, and their effect will not be long lasting. It's an artificial high.

Another important question: are the factors that could contribute to home price declines more than likely to outweigh the recent increases? I think yes.

A higher outflow of distressed property is long overdue.

Lending will eventually return to higher rates and traditional 20% down payments: no more FHA lending subsidy to artificially prop up the market.

Jobs are still scarce, except for the highly skilled. This means less demand for housing on the low end. Companies have been able to hold back on salary increases because of a slow economy, and know full well that employees would rather stay in their job than take chances in the current job market looking for something better. Stagnant wages will widen price-to-income ratios and put downward pressure on home prices over time. And student loan debt will continue to be a huge financial obligation for young, potential first time buyers, which severely constrains the emergence of a move-up market.

What we are seeing now in prices is nothing more than a small rally that is limited to a few, high demand, low inventory areas. This is likely to continue into the Spring of 2013. A large contributing factor to recent price increases is the result of bidding wars for very limited numbers of formerly distressed properties that were acquired through tight connections by investors looking for a quick flip.

The sharp price declines of 2007 should have continued well beyond 2011, but did not because of a government induced slowdown in foreclosure activity early in 2012. Lenders are basically waiting for the outcome of the election next week to know what action they will be able to take next to better deal with large numbers of delinquent borrowers. Lenders hands are tied at the moment, but they want badly to clean this up.

Short sales are providing some relief to lenders who are unable to deal effectively with delinquent borrowers. The few short sales that do hit the market are long overdue. Some lenders give short sellers incentives to move on. But it's difficult to turn a delinquent borrower into a short seller when they have the option to squat indefinitely at no cost. And this behavior is encouraged by tight regulation on lenders to deal with squatters.

The fundamental problem remains unresolved: too many people continue to be way in over their heads. While a short rally in home prices has allowed some people to escape a negative equity situation (like me), this is a much smaller group than the large numbers of people who purchased way too high, refinanced (cashed out), took out a HELOC, signed up for a teaser rate on that second mortgage, and are now delinquent on all of the above. As long as this large lump continues to sit, off the market, we may never see a true recovery.

Another shake out is badly needed.