Monday, August 31, 2009

The effect of interest rates on prices

In an earlier post a reader commented on the effect of rising interest rates on prices, and when the bottom would be reached.

"I am curious about increasing interest rates and how they will affect when the bottom is called. How cheap does the house have to be to offset increasing interest rates? "
So I ran a simple scenario.

A $200k loan at 5% interest over 30 years gives a monthly payment of $1074.

If interest rates increase by 1% (a 20% increase) then the same $1074 payment only gets you a $179,134 loan. That's a 10.4% decrease.

So if the bottom of the market is driven by buyers who are buying the max they can afford, and assuming lenders actually go back to the days of the 28/36 rule (PITI no more than 28% of your monthly gross income, total dept no more than 36%) then if interest rates rise 1% it will theoretically drive down prices approximately 10%.

The reader had another comment:

"I remember Portland housing costing as low as $10,000 in the Alberta Arts district. (1990). A nice house in Hawthorne could be had for $60,000 around that time. Of course interest rates were around 21% and no one could afford the payments back then."
I'm pretty sure that 21% interest was back in the early 80's but that's not the point. If interest rates did rise that high again, then that $200k loan suddenly plumments to $61k. That's a scenario nobody wants, not buyers or sellers.

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patient renter said...

If interest rates did rise that high again, then that $200k loan suddenly plumments to $61k. That's a scenario nobody wants, not buyers or sellers.

Except for buyers with $61k in cash :)

PDX Outsider said...

LOL, true.

Then again I'm not sure what the rest of the economy would look like if interest rates were 21% again.

Leigh said...

oohhhh, think of those CD rates!:O)

Anonymous said...

I stand corrected. You are right about the interest rates. I think by 1990 they were down to 14%. I knew someone paying that amount anyway. It was the 1980's that the interest rates were 21% for a mortgage. (There were also balloon mortgages) My memory gets fuzzy that far back.

I have lived in Portland since 1980. A lot of the neighborhoods were pretty bad. Especially North and Northeast. Bad areas were below 7th towards the river in NE and anything North of Fremont St were basically slums. (Some exceptions to this after you got above NE 20th I think). MLK had hundreds of prostitutes working the streets. So many that when people would come from out of town the prostitutes were part of the tour. Portland was really down in the heals. When I moved here the official unemployment was 12%. I believe it was actually more (unofficially) at around 16% or so, counting the people that exhausted their unemployment benefits and were no longer counted. Back then a basic office job would get 200 qualified applications. I moved here from Eugene as it's unemployment was even worse!

I think housing prices are insane too, but I don't want it to go back to the 1980's again. Even though back then you could get a nice house for $20-30K. No job to pay for it though. Portland and Eugene jobs were based on forest products and the building of housing had collapsed because of high interest rates. Anyway I am hoping that things straighten out soon, as I was glad Portland came out of that bad recession in the 1980's and got back on it's feet again. It is nice to see all the old neighborhoods and houses fixed up now.

Thanks for running the numbers. Kind of scary if interest rates go up again.


PDX Outsider said...

"I have lived in Portland since 1980. A lot of the neighborhoods were pretty bad. Especially North and Northeast. Bad areas were below 7th towards the river in NE and anything North of Fremont St were basically slums. (Some exceptions to this after you got above NE 20th I think)."

Yup, that's where we live, and we love it. LOL! The benefits of a fresh perspective and not coming to the party with prejudices.

Anonymous said...

By the way, nice website.

I cannot even afford North and Northeast Portland and those are great neighborhoods now. I bought my house in 2003. It was a moderate fixer-upper in a crime infested neighborhood. Now the neighborhood is nice to live in. Many, many people bought into this neighborhood over the last several years and took it back from the drug dealers and criminal element. People turned into the police dept several drug houses which were a major livability problem. (There were 2 drug houses on my block alone). Now all the drug houses are gone. This same thing has happened over the last 15 years in neighborhood after neighborhood as people took back these blighted neighborhoods, and made them nice places to live in again. The police really have helped a lot, as do the neighborhood associations. I really noticed this change happening in Portland starting around 1993 or 1994.

People also bad mouth the house flippers, but they helped renovate the run down houses and the neighborhoods. They took a house with very little value and fixed it up and then sold for a profit. That is fine by me. For example the house down the street was owned by a lady for 30 years with 20+ cats. When she died the house was trashed and foul inside with cat waste and urine. (The house and the yard was also filled with trash). No one but a flipper would of touched it with so much damage. A flipper bought it and fixed it up. When it sold, a very nice family moved into it. Otherwise it was so trashed it would of sat empty and become a public nuisance. Now mind you I am not writing and defending the condo flipper that buys a new condo, never lives in it and then sells for a 30K profit. That is unethical in my book. But to purchase and renovate a down in the heels or drug house property then resell for a profit to a decent family gets kudo's in my book.

I have watched with pride as each bad neighborhood gets reclaimed from the drug dealers and hoodlums and becomes nice again. I have a love of old houses and beautiful gardens.

Also, thanks for running the interest numbers. I have read that the tolerance for higher interest rates is around 7%. Then people slow down the purchase of housing. We are about 5.25% now I think. So based on these numbers, a $250K house could fall another $50K before bottoming out as interest rates hit that point where it is to expensive to borrow. Of course at 7% the cost to borrow is higher and will make the cost of the house higher. Not sure how much higher over the cost of the loan.

How do the numbers run based on a 250K house purchased now at 5.25% and then the same house valued at 200K three years down the road (if prices do fall) purchased at say 8%?


Anonymous said...

Your numbers are close but the payment on a $200,000 loan at 5% are $1069.19 per month. That same payment would get you a $179,223.30 loan at 6%.

Interest rates were at around 9% in 1990 but the Alberta area was very scary. Same for the area east of NE 15th. Pimps, crack dealers etc. ruled. Lots of drive-by shootings etc.

Leigh said...

So where did all the druggies and prostitutes go? Seems like it just pushes them to another area. Folks don't come clean just because the neighborhood did. Did we give Gresham our problems?

I used to live near DaVinci Middle school in NE and saw numerous drug deals done in cars. No need for a drug house.

It's wonderful to reclaim neighborhoods and all but I think it just passes it on to the next:O(

NW 23rd area used to by quite ugly, too, in the 60's and early 70's I hear. Talk about reclaiming a neighborhood!

Dianne G said...

OK, I've gotta pipe in here. First, a shout out to Charles Moose. Does anyone else recall when he bought a house in a rough area in NE as chief of police and then challenged the community, and Realtors in particular, to re-invest in the inner-city neighborhoods. I think he had a big impact on what we have seen since then.
Then I've got to share that my mom was a Realtor in the mid 1980's with a listing on about 15th and NE Sumner. She had to call 911 and get police to go with her when she went to check on her listing. It was a foreclosure with boarded up windows that was used as a drug house. I think it sold for about 14K in about 1987.

Anonymous said...

Gotta laugh when you make the case that interest rates affect affordability of housing here but when you clint posts his "affordability" graph making the case that the median price needs to be less than 3x the median income, interest rates make no difference.

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Anonymous said...

Has this blog been abandoned? New Case-Schiller numbers out.

PDX Outsider said...

"Has this blog been abandoned? New Case-Schiller numbers out."

Nope, I was just on a fabulous 3-week vacation with no PC or phone. It was wonderful. Sorry for the posting break!