Low interest rates don’t make housing more affordable.

Supply and demand are the biggest determining factors in housing values.  While getting a lower interest rate loan will reduce a payment in a specific house purchase, the long term effect of low interest rates is simply housing inflation.  From a macro/market perspective, interest rates have a supplemental and often artificial impact on values.

Investing, investment, real.

Rate cuts in recent years were not about making housing affordable to the public.  The lowering of interest rates was intended to stimulate buying and inflate housing values out of the red to stop the foreclosure crisis.  And while it has solved some problems, it is unclear if it doesn’t create other problems in housing’s future.

For some historical context, let’s go back to pre-bubble years.  The near unlimited supply of mortgage credit caused housing prices to rise dramatically from around 2000 to around 2005.  Banks would lend lots of money to anyone willing to borrow.  This was for a variety of unsavory reasons (Discussed Here) but the net effect was to stimulate buying and therefore demand.  More people entered the market increasing competition and driving prices up.  People who were never before in the housing market were now told they could afford a house and they set out to buy one.  Many others started investing in income properties and bought house after house.  As the market swelled in size the demand for houses swelled well past supply driving prices up.  Sadly, much of this new market wasn’t really qualified to borrow or buy and would soon exit the market.  

Around 2005 it all began to unravel.  People who could not afford the loans they took could no longer continue to make payments and walked away or were booted out.  Home availability (supply) began to soar.  Further, it was also recognized that house prices were overvalued and people became very cautious about buying and demand dropped.

Basic economics dictate prices are going to fall in this environment.  And did they ever.  Foreclosures and short sales were everywhere and prices plummeted.

House for sale

Now here’s where this story gets sticky.  Despite a high availability of homes at as much as half the price of a few years earlier, and in the name of making houses more ‘affordable’, interest rates began dropping to levels not seen in a generation.  And while arguably it did make houses more ‘affordable’, temporarily, it simply fueled major buying of houses again.  As buyers were inspired by unheard of rates to borrow, the market demand once again began to soar.

Of course my occasionally cynical nature wants to point out at this time (the market bottom) institutional investors bought most of the now undervalued housing market.  If you were around trying to buy a house between 2010 to 2013 you were competing with cash buyers buying at over market prices. Buyers would race to see new properties and write offers that would compete with 10-30 other offers.  And like most ordinary people needing of a loan and subsequently an appraisal, you could not compete with over value cash buyers.  Sadly, much of the most attractive pricing on homes simply went to Wall St.  I’m sure glad the Government and the Federal Reserve don’t hire former Wall Street executives (sarcasm intended).

Supply plummeted as homes were purchased and in this high demand environment, prices once again skyrocketed.  Once the investors’ appetite was satisfied, finally real people wanting homes came in and continued to buy and prices rose more.

So who benefits from low interest rates?  Clearly stimulating demand with low interest rates was intended to stop the collapsing housing market and restore stability.  Investors who owned troubled mortgage backed securities had their remaining investments stabilized.  Investors buying undervalued homes knowing that low interest rates would cause a run up in housing prices did extremely well. Underwater home owners are now less underwater or possibly beginning to build equity and as such the likelihood of selling in distress (foreclosure/short sale) is greatly reduced.  And lastly, house buyers that purchased while housing was still undervalued and interest rates were artificially low, did well too.

In the end, however, housing finds a new price balance based on supply and demand.  Loans may be cheaper, but houses are now more expensive.  The net impact on affordability in housing is zilch.1910099

Further, this temporary manipulation makes housing more vulnerable.  What happens to demand (and prices) when interest rates rise again to more sustainable levels?  This will be worth keeping an eye on as rates are now beginning to rise.

If we want to see housing become more affordable, we need to increase supply and  build more houses.  Public policy should focus on easing regulatory burdens and stimulating more housing construction with incentives.   If anyone genuinely cares to make housing more affordable, build houses, don’t manipulate markets.