An article from today's Wall Street Journal. Unfortunately I can't copy the accompanying chart. But it shows that cities like Boston are very overvalued at 5% interest rates and will be more so if rates rise to 8%. Don't understand the analysis. The methodology is not really explained so it is a mystery why they conclude that coastal towns are more susceptible to interest rate spikes, while other cities appear to suffer less under high interest rates. The locales with negative price changes (projected to 2006) under both a low interest and high interest scenario are Boston, LA, DC, Orange County (SFO is not included in the list at all for some reason).
Why Your Home
Might Sell for Less
Analysis of Cities Shows Where Higher Rates
Would Hurt the Most; Pittsburgh vs. Seattle
By RUTH SIMON
Staff Reporter of THE WALL STREET JOURNAL
Higher mortgage rates don't just take the fun out of refinancing. They could also reduce home prices in some parts of the country.
As interest rates rise from the summer's lows, that is one of the bigger risks in the economy for Americans whose best-performing asset over the past few years has been their home. But it would be a mixed blessing for buyers already priced out of many market. They might pay less for the house but would face higher borrowing costs.
A 25-city analysis by Fidelity National Financial Inc., a real-estate services provider, shows that rising rates will have a sharply different impact on various regions of the country. The study, conducted at the request of The Wall Street Journal, found that many of the markets that have seen the sharpest appreciation now stand to be the hardest hit.
For example, a median-priced home in Boston, currently worth $407,000, would see its price tumble by $59,000 by 2006, if the rate on a 30-year fixed-rate mortgage climbed nearly two percentage points to 8% next year and stayed there, according to the Fidelity National study. Other vulnerable markets include several California cities, Seattle and Washington, D.C.
Fidelity's analysis suggests that rising rates will cause the most pain in markets on the East and West coasts where it's hard to build new homes to meet rising demand. "Because people know there's a limited supply of homes for sale...you get almost a frenzy," says Fidelity chief valuation officer Michael Sklarz.
Rising rates would have a much more muted effect in less frothy markets like Pittsburgh, where the median home sells for just $108,000. If the rate on a 30-year mortgage rose to 8%, that home would still rise by $6,000 in price. The Fidelity analysis looked at how rising rates would affect home prices in the 25 largest metropolitan areas.
Interest rates play a far more important role in housing than in any other consumer market. Because homes cost so much and because they're financed over such a long period of time, even small changes in rates can have a big effect on prices that buyers are willing -- or able -- to pay.
While rates remain low by historical standards, they already have risen significantly since this summer. Thirty-year fixed-rate mortgages now average 6.08%, after bottoming out at 5.31% in mid-June, according to HSH Associates, financial publishers in Butler, N.J. The Mortgage Bankers Association expects rates to reach 7% in 2005.
Higher mortgage rates would impact the housing boom in a variety of ways. Higher rates make it harder for borrowers to qualify for a loan and reduce the size of the loan they can obtain. A borrower earning $50,000 could purchase a $195,000 home at 6% mortgage rates. But using the same lending standards, that borrower could only afford a $159,000 house if rates climbed to 8%.
Higher rates also mean bigger monthly payments. On a $350,000, 30-year fixed-rate mortgage, the monthly payment climbs by $470 to $2,568 when rates are at 8% instead of 6%.
So far, the impact of rising rates has been limited. Sales of existing homes surged in September, setting their third consecutive monthly record, according to the National Association of Realtors. Median home prices climbed 9.1% in September over a year earlier, according to the National Association of Realtors.
The Most Vulnerable Markets
Still, if mortgage rates do climb to 7%, that's "high enough that it make a big difference in people's thinking," says Mark Zandi, chief economist at Economy.com in West Chester, Pa. The housing market is particularly vulnerable to rising rates, he adds, because so many people took advantage of low rates and bought homes earlier than they would have otherwise. Home-ownership climbed to record levels in the second quarter, according to the Commerce Department.
UP, UP AND AWAY
See where rising rates are affecting home rates. Adobe Acrobat required.
Federal banking regulators are already keeping a close eye on the potential risks. In a paper delivered to the Federal Deposit Insurance Corp. Board of Directors on Tuesday, FDIC economists warned that, "Home prices in less-affordable housing markets could be particularly vulnerable [to rising rates], since median family incomes are already straining to finance median priced homes."
Not everybody agrees with this warning. The same areas of the country that have high prices also have housing shortages, notes Lawrence Yun, a senior economist with National Association of Realtors. As a result, he predicts these regions won't be hurt more than other areas of the country by rising rates.
Blunting the Damage
Other factors could blunt the damage, as well. A briskly growing economy could put more money in workers' wallets, providing a cushion against rising rates. In addition, as prices rise, more buyers are also likely to opt for adjustable-rate mortgages, which are tied to short-term rates that haven't yet moved upward. Adjustable-rate mortgages now account for 25.4% of mortgage loans, according to the Mortgage Bankers Association, up from 14.4% in mid-June. "It's a dandy shock absorber," says David Seiders, chief economist for the National Association of Home Builders.
But there are some signs the housing market could be cooling off. Housing affordability fell in the third quarter to its lowest level in a year, according to the National Association of Realtors. The Federal Reserve Board reported this week that demand for loans to purchase homes fell in the third quarter, the first drop in two years.
Home price growth has also been slowing. Home prices increased at an annualized rate of 3.13% in the second quarter, according to the Office of Federal Housing Enterprise Oversight, which regulates government-sponsored mortgage companies. That compares with an 8.77% rate in the year-earlier period, and is the lowest rate of increase since the fall of 1996.
For overheated markets, a slowdown in price appreciation would be a welcome breather. In some parts of the country, the buying frenzy has pushed prices out of line with local incomes. In California's Orange County, for instance, less than one in five households can now afford the median price house, according to the California Association of Realtors.
But when rates rise, home prices in such markets are likely to sink for several years or move sideways before they recover, according to Fidelity's analysis. In Orange County, for instance, 8% mortgage rates would push prices down 10% by 2006, according to the Fidelity study. In the center of the country, where prices never got so rich, rising rates are more likely to simply slow the rate price appreciation, not stop it.
Pricey Coasts
Coastal markets also tend to be more sensitive to rising rates because the homes cost so much. In Los Angeles, where the median home price is $315,000, the monthly payment on a 30-year mortgage jumps by $423 if rates rise to 8% from 6%. In St. Louis, where the typical home goes for $117,000, that rise in rates would boost the monthly mortgage payment by just $157.
Write to Ruth Simon at ruth.simon@wsj.com |
