The Relationship Between Mortgage Rates and Home Prices

Posted By PK Last updated October 3rd, 2012 12 Comments

We’ve got a treat for you today – a spiffy graph we created with Google Drive (née Documents). Thanks to comments from fellow Burbed commenter SEA on this article, we decided to take another look at the relationship between home prices and mortgage rates.

Thought we did it once before? Not quite – we had a synthetic measure of ‘affordability’, which we defined as fitting into a front end debt to income of 25%. Got it? Our last article talked about home price affordability, this one talks about absolute home prices.

The Relationship Between Prices and Mortgage Rates

We’ve only got enough data to go back to 1975 here, so this isn’t the best possible analysis. Convince us to use the Shiller data on home pricing, and maybe we’ll build you a tool like our S&P 500 return calculator. Or, maybe not. Let’s see what these last few years show. (Here is my data, thanks to the St. Louis Fed and the Census Bureau)

So there you have it – there is a strong correlation between prices and 30 year mortgage rates (for median prices roughly -.75, or an R^2 of ~.58). However, the correlation is with absolute prices, not with changes in price. There is no correlation between changes in price and changes in mortgage rates.

So Will Lower Rates Drive Up Prices?

Maybe – but it’s not going to be perfect. A lot of the correlation during the period might just be the move to stable price controls since Paul Volker considering the entire period has roughly seen decreasing mortgage rates. The only two times the correlation starts to go awry are during the high inflation/mortgage rates on the 70s, and during the recent recession (although there are signs of life).

So, do I think we can re-inflate the balloon? At some point, the excess liquidity from artificially low mortgage rates will probably do something – but will it be worth it?

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AverageJoe

I’m not seeing the correlation….maybe I’m dense. It seems there are too many other factors at play here. Is it a correlation that states prices rise or prices fall? Because you could make the statement (had you backed the train only up to 2006) that there’s a strong correlation with prices and rates that is the opposite of what I think you’re suggesting. True? …or am I just missing it today? (Only one cup of coffee number one, so maybe it’s going right over my head).
- http://www.dqydj.net/ PK
  
  No – there is a very strong correlation between prices and mortgage rates. R^2 of .57 is pretty strong – and the -.75 I mentioned means they are negatively correlated (lower mortgage rates, higher prices). I’m saying that correlation died a bit in the 70s and post-bubble – one where rates increased and so did prices, two where rates decreased and so did prices.
  
  My main issue is I don’t think I have enough data here. The era since Paul Volcker (August 1979) has had Fed Chairmen of a similar type – and the mortgage rate has fallen under all of them, while home prices have gone up over most of that span. I wonder if that’s just coincidence or causation!
Nicholas Casteel

Interesting how one truly affects the other. In this case it is a logical correlation. Most people could not afford to pay rates approaching 20% on a $200k + home, or on any debt for that matter. It would be interesting to see this chart for the 35 year period prior to 1975 to see how that correlated. The question everyone wants to know is what is going to happen in the future. Certainly rates can’t stay artificially low forever (government propping them up using a variety of stimuli). So, what will happen to home price when rates at some future point begin to raise again?
- http://www.dqydj.net/ PK
  
  Yeah, I need to get my hands on some older data. The oldest on the St. Louis Fed site is 1964, but it is FHA rates (this dataset starts in the 70s). If you have any source pass it along and I’ll use the Shiller data to go back further.
freeby50

What if you adjust home prices for inflation?

I would assume that over any long term period housing prices will go up in general. Thats almost a given based on inflation. I don’t think we can conclude much about any correlation between upward trend in home prices and another variable like this since home prices go up in general.

Another detail is that home sizes gradually go up over that time period. So median prices in 1970 might have been for a median size 1500 sq ft house while the median price in 2005 was for a median size 2500 sq ft house. So bigger houses would throw off the trends too, since bigger houses naturally cost more.

To me the observation that : “There is no correlation between changes in price and changes in mortgage rates.” is important. This says that the year over year increases and decreases in mortgage rates don’t correspond with similar changes in home prices, right?

I think the idea is that : “if interest rates go up then doesn’t that mean that home prices will go down” or vice versa that ” if interest rates go down wont’ that help increase home prices”? Seems logical. I mean if I can get a mortgage at 2% then I can buy much more house than I could get if the mortgages were 8%. But there are so many other variables involved its hard to sort that out.
- http://www.dqydj.net/ PK
  
  Definitely I could do that – I’m concerned with how to adjust mortgages though. We know that mortgage rates are affected by inflation, but the spread has been narrowing lately. Any suggestions?
Jsomm

I am going from memory here but I recall 30-year mortgage rates (fixed) being around or over 15% in the early to mid 1990s. This graph shows they were under 10%. I’m just not sure that was accurate.
- http://www.dqydj.net/ PK
  
  Maybe it was credit dependent? These numbers are direct from Freddie Mac (you can find them here at the St. Louis Fed). Or maybe it was a regional thing? I recall rates around there, but I was in Rhode Island at the time.
- CameronDaniels
  
  You might be off a decade. The >15-20% range was in the early-to-mid 80s. Since Volcker came in they have been on a general rolling decline.
JT

“There is no correlation between changes in price and changes in mortgage rates.”

This is the only thing worth studying, in my opinion. The change in price and the change in mortgage rates.

Buying a home is to buy a perpetuity of rent cash flows that you would otherwise pay to someone else. Given that home values share a very weak historical relationship to rents (the price to rent ratio range is HUGE from tops to bottoms), I’m not surprised with the data – not surprised that there is no correlation between the change in interest rates and the change in price.

Your numbers essentially prove that the cost to build a home has gone up over time, not that prices are related to interest rates. Unless homes fall tremendously, everyone abandons their home, and prices are allowed to reset in some crazy secular doomsday scenario in real estate, home prices are unlikely to drop even if rates go up just because the cost to replace a current home will still be on the up and up. The cost to build a home is what keeps home prices muted during periods of heavy construction, and what keeps home prices higher during periods of weak housing construction.
- http://www.dqydj.net/ PK
  
  You mean the first derivatives?
  
  I actually expected something here – it makes logical sense that a dropping rate should come with a dropping price, but nope, nada thing.
  
  And yes, prices have gone up. I think a lot of that is covered by FreeBy50′s comment – inflation makes things cheaper. However, don’t forget the thing that is really appreciating is land – the only time a structure’s value goes up is when you improve it (and then begins to decline again, haha). So you need a structure to make it rent-able as a residence, but the value is in the land.
  
  And yeah, I don’t see that doomsday scenario in most places. However, we have seen something similar happen to Detroit – so it certainly is possible.
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The Relationship Between Mortgage Rates and Home Prices

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