Changes in interest rates affect local, national and
international economies in a bewildering variety of positive and negative ways
depending on the segment, and there is vehement disagreement as to what rate or
rate movement is best, or most dangerous, for whom.
As of Friday, November 18, mortgage interest rates have
jumped about 15% since the election, with many economists and analysts
predicting more to come in the not too distant future. Federal
Reserve Bank Chair Janet Yellen recently suggested that the Fed is
close to lifting its benchmark interest rate. However,
predicting interest rate changes; what factors might arise to cause movements
up or down; as well as the direction, scale and speed of changes; is enormously
difficult. Witness the thousands of incorrect expert predictions over the past
10 years. For that matter, rates actually
after the Fed last raised rates in December 2015.
This report will focus on a single issue: Increases in interest rates raise the ongoing cost of
housing and reduce housing affordability (unless there is a concurrent drop in
prices). In the Bay Area, already experiencing significant social and economic
ramifications from the high cost of housing at a time of historically
low interest rates
, this is a big concern, including how it might
affect our real estate markets.
The degree of the effect of any interest rate changes will,
of course, depend on what actually occurs at what speed, which is beyond
our ability to predict. The possible scenarios in this report do not imply any predictions
on our part. The first charts below provide some useful context.
Bay Area Home Price & Affordability Trends by
From 2012 through Q3 2016, Bay Area home prices in most
counties soared to new peaks. Affordability percentages dropped dramatically
since 2012, but without quite reaching the lows of 2006-2007.
In this report, affordability is calculated, under the C.A.R.
Housing Affordability Index methodology, using 3 main criteria: 1) the county median
house sales price, 2) the prevailing mortgage interest rate, and 3) county household
income distribution percentages.
Long-Term Interest Rate Movements
The drop in interest rates from 2007, the last peak of
market before the 2008 crash, through early November 2016 has been incredible. And
the rates prevailing prior to the 2008 crash, in the 6% range, were themselves
quite low by prior historical standards. The average annual rate from 1990
through 2007 was 7.4%. Just prior to the recent 2016 election, rates were
between 3.5% and 3.6% (with an all-time low of 3.3% hit in 2013). The chart at
the top of this report illustrates the sudden post-election pop in rates to
Interest Rate & San Francisco Median Price
Changes since 2007
Home prices and interest rates dropped precipitately after the
financial markets crisis of September 2008. Once the real estate recovery began
in 2012, home prices skyrocketed while interest rates generally continued to
bump along at or near all-time lows.
In effect, the big reductions in interest rates subsidized
much of the surge in Bay Area home prices: Since the last peak of the market
prior to the 2008 crash, to just before the 2016 presidential election, the
interest rate for 30-year, conforming, fixed-rate home loans, fell about 43%,
from roughly 6.3% to 3.6%.According to the
S&P Case-Shiller Home Price Index, overall Bay Area home prices have
appreciated approximately 82% since 2012, though, please note, appreciation
rates vary widely by specific location and home-price segment. The above chart
shows SF median price changes only.
The decline in interest rates was not the only or even the primary
factor in the appreciation of Bay Area home prices. The massive increase in employment,
much of it high-paid, and the resultant surge in population (without a parallel
increase in housing supply), along with the local explosion of new wealth from
our high-tech boom, were the primary factors. Still, there is no arguing that
plunging interest rates made increasing home prices much more affordable.
These interest rate rise scenarios below do not imply
predictions on our part: A top interest rate scenario of 6.3% was chosen simply
because that was the rate in 2007, the peak of the last cycle.
Short-Term Interest Rate Movements since December
The same chart that began this report
Post-election increase: Short-term spike
or beginning of a longer-term ascent?
Monthly Housing Cost Scenarios
Illustrated Using the San Francisco Median House Price
Approximate monthly principal, interest, taxes and insurance
costs for the purchase of a Q3 2016, median-priced San Francisco house at
$1,300,000, using an 80%, 30-year fixed rate loan, at a number of interest rate
As seen below, the 15% increase in interest rate from
11/10/16 to 11/18/16 added almost $4000 to the annual housing cost of
purchasing a $1,300,000 home. If the rate goes to 4.5%, the increase is about
$6700, and if it goes up to 5%, the additional annual cost of housing is over
$10,000. Illustrating how declining interest rates help subsidize increasing
home prices, the Q3 2016 SF median home price was 45% higher than the previous
peak price in 2007, however the increase in monthly housing costs (PITI) was
only 14% higher than in 2007 due the big drop in mortgage rates.
Minimum Qualifying Household Income
The below chart tracks approximate household income needed
to qualify for the purchase of a Q3 2016, median-priced San Francisco house at
$1,300,000, using an 80%, 30-year fixed rate loan, per associated PITI costs,
at various interest rates.
As interest rates increase, household income requirements
increase. Before the election, buyers needed an approximate income of $251,000
to qualify for financing their purchase of a median priced SF house, with a 20%
down-payment. By Friday, November 18, the income requirement increased by
$13,000. And if the interest rate goes up to 5% (and again, we are not saying
it will), an additional $35,000 in annual income would be required.
Housing Affordability Trends for San Francisco
If housing costs increase, then housing affordability
declines. In Q3 2016, the percentage of San Francisco households who could
afford to purchase a median priced house, at 14%, was 6 points higher than the
all-time low of 8% in Q3 2007. The recent interest rate increase through
11/18/16 drops that another percentage point. If additional rate increases
occur, then, all things being equal, San Francisco will continue to move closer
to the historic low hit at the peak of the last market cycle. And, of course, the affordability percentages of other Bay
Area counties will also drop. (San Francisco, San Mateo and Marin have the 3
lowest percentages in the state, and must be in the running for lowest
percentages in the country.)
To what exact degree interest rate changes would affect
local real estate markets is unknown. Much would depend on the scale and speed
of change as well as other economic trends in the Bay Area - such as high-tech hiring
and IPOs coming to market - as well as macro-economic trends in the nation. But it could include a slowing of transaction
activity and new construction projects, possible adjustments to home prices, or
the continued pushing of buyers from more expensive areas to less expensive ones
(including, possibly, those outside the Bay Area). High housing costs are not an easy
problem to fix, and increasing interest rates, if they continue, are unlikely to help.
All the statistics and numbers used in this analysis are
based on data deemed reliable but should be considered approximations and
generalities, most useful in illustrating comparative values and broad trend
lines. By definition, half of the homes sold cost less than the median sales
price, and greater percentages of households could afford their purchase. Also
other property types such as condos are typically significantly less expensive
than houses, so they would be more affordable as well. Our gratitude to the
California Association of Realtors, and in particular, its analyst Azad
Amir-Ghassemi, for all their work on the Housing Affordability Index (HAI). For analyses and scenarios after Q3 2016, the numbers
reflect our best estimates based upon our understanding of the CAR HAI
methodology, and/or housing cost calculators. None of the interest rate
increase scenarios included imply any predictions on our part that such
increases will occur. Anyone contemplating purchasing a home with financing
should confer with a qualified loan agent and their own financial planners. This
report was written in good faith, but may contain errors and is subject to
© 2016 Paragon Real Estate Group