| Why Rising Interest Rates Will Hammer Housing
by Blanche Evans
For many areas around the country, buyers are way ahead of Alan Greenspan.
Sales are already "flattening out" as the Fed chief predicts will happen, because
buyers in many metros are beginning to assess their risk and deciding it's too high.
Overheated housing markets such as San Diego
<http://realtytimes.com/rtmcrloc/California~San_Diego> are beginning to report mild
rises in inventory and longer days on market, signals that the housing frenzy may be
abating, while buyers' markets like Dallas
<http://realtytimes.com/rtmcrloc/Texas~Dallas> are sinking further into apathy with
every 1/8 point rise in interest rates as buyers decide that affordability is a bigger
factor than opportunity.
New loan products and a relaxed lending environment, a lousy stock market,
favorable tax laws and above average house sale returns, among other conditions have
encouraged record homeownership to 68.6 percent last year. But many homeowners may get
stuck in properties they can't sell if the nation sinks into a housing recession.
There are just as many factors on the negative side of the housing column to
suggest that could well happen: rising interest rates, record consumer debt service,
lack of real job creation, fears over terrorism and the coming election, to name only
Every eighth of a point rise in interest rates impacts buyers' open-to-buy by
adding as much as $25 or more per month to the monthly payment, depending on loan
type. Consumer debt has reached 110 percent of disposable personal incomes. Despite a
pace of three million new jobs created by year's end, unemployment figures are flat at
5.6 percent, if down from last year's peak of 6.3 percent. But, that figure is still
1. 6 million less than the number of jobs lost since 2001. Further, many new jobs
don't pay what previous jobs did, according to the Economic Policy Institute. And, a
2.2 percent gain in earnings this year holds little comfort to those paying 35 percent
more for a gallon of gas or double the price for a carton of milk, and eight percent
more for housing nationally.
A primary but undocumented factor is the change in attitudes buyers have about
homeownership. Homes, in the "new economy," are no longer a place to live, but an
investment. Many homeowners have adopted a kind of daytrader mentality toward their
abodes, flipping homes for hefty profits, using their bankers' money. Other homeowners
have cashed out their equity to service other debts or to make improvements. Many have
purchased their homes with so little down that they can't afford to sell except at an
Never before has the home been such a crucial instrument of financial
The prevailing notion among sellers is somehow that buyers should pay them for
having made such a clever investment. Further, sellers believe they are entitled to
sell at a profit - they want to get paid for occupying the home, even if it was for a
short amount of time and their largesse is due to bankers' goodwill. Making no sense,
but a factor, nonetheless, is that many homeowners who were burned in the stock market
meltdown of 2000 believe they should be able to make those gains back with their
housing investments. This is particularly true of retirees and empty nesters.
Since 1980, according to the National Association of Home Builders, "home
prices on average have increased around five percent annually and have never shown an
annual loss." In fact, the housing market has been so good over the last eight years,
that many homes have appreciated as much as 40 percent on average.
No wonder sellers have come to expect profits on their homes. And that's the
key word here - expectation.
But buyers have expectations, too. They expect to realize equity, too, and now
they are being told by the nation's most powerful economists that housing appreciation
is slowing, interest rates are set to rise, and that job growth will offset rising
But for many the reality is different from the national statistics.
Nationally, markets differ. California may be in a housing boom, but Texas is not. And
booms turn into busts sooner or later.
With interest rates rising, home appreciation is expected to slow, according
to National Association of Realtors' <http://www.realtor.org/> economists. Buyers
will want to be rewarded for buying in markets where slowing or flat home appreciation
means more risk to equity-building.
They not only don't want to pay the seller for occupying the home, they want
some of that unrealized equity for themselves. They aren't as swayed by arguments that
lending rates are at 30-year-lows as they have been, because interest rates have
hovered at low levels for over six years. All they know is that they are paying a
point more in interest than today than four months ago, and that alone should slow
housing sales in many markets. Another point, and housing will come to a halt. Not
only will housing become too expensive, but so will debt service on other debts.
If buyers are going to become homesellers one day, they want the same thing
current homesellers have received for the last eight years - instant equity. But
equity can only be built with rising home values over time, because all loan products
pay interest to the lender with little or no reduction in principle for years to come.
If housing values go flat, it takes more time to build equity, and with the average
homeowner staying only four to seven years, that isn't enough time to step over a flat
or declining market. And there is the risk that a future selling environment could
call for homeowners to bring money to closing, as happened to many homeowners in the
late 80s and early 90s.
Buyers may recognize the signs that, suddenly, the conditions that favored
homebuying are beginning to lose their underpinnings. Rising interest rates, a rising
stock market, advancing inflation, sluggish job growth are all present. The high hopes
of many economists who say that housing won't be significantly hurt by rising interest
rates and slowing housing appreciation, are gambling that job growth will outpace
inflation, and so far there's no indication that is happening.
And then there's human nature. No one wants to buy high and sell low. To get
buyers to buy in that kind of a market, they have to be convinced that their risk will
be rewarded, and there are only a few ways to do that since the simple joy of
homeownership is no longer enough to get investment-conscious buyers to take the
What rewards them are incentives to buy - discounts, concessions, and
The best way to reduce risk, they may come to believe, is to do what worked
for them in the stock market - sit on the sidelines to get a better deal. Deals may
seem few and far between while interest rates rise, reducing affordability and the
range of qualifying loans, and while sellers hold on to high prices.
That leaves buyers no choice but to pressure sellers to give up some of the
inflationary increases in their home values over the last few years. Buyers will put
more pressure on sellers to reduce the price of their homes and to accept contracts
with contingencies, along with ordering more repairs, and demanding more improvements.
The inability to build equity in a home means there is risk in liquidity, and
that is the biggest factor to hurt housing sales. Housing and the stock market will
change places as the stock market moves back in favor, and rising interest rates makes
housing look less favorable. Just as stock buyers did in the stock market, housing
buyers can afford to wait on the sidelines and buy on the dip.
Published: June 23, 2004