The Trouble with Sharply Rising Mortgage Rates

Buyers naturally dislike higher mortgage rates, but sharply rising rates may even jeopardize the housing recovery.

May 25, 2014 at 11:37AM

There are indications that the rise in mortgage rates over the past year may have stalled the housing market's recovery. With the Federal Reserve continuing to taper off its purchases of mortgage-backed securities, mortgage rates could rise further in the months ahead.

This raises a fundamental question about the housing market: Can home prices survive higher mortgage rates?

Here are some comparisons between current and historical numbers to see how housing prices might fare.

Historical precedents
Home prices have risen fairly steadily since the beginning of 2012, but new home sales were off sharply in March, and were also down year-over-year. Of course, over that same year mortgage rates have risen, leading to the question of whether higher mortgage rates will kill the housing recovery. One way to examine this is to consider the historical relationship between mortgage rates and home prices.

History never repeats itself in exactly the same way, but it is often a good guide to possible market behaviors. Here are some historical perspectives on current data:

  1. Mortgage rate history. Current mortgage rates are around 4.3 percent. One of the difficulties in comparing current mortgage rates to historical levels is that rates have rarely been at that level. Thirty-year fixed mortgage rates were between 4.0 and 4.5 percent from August 2010 to November 2010, and again from August 2011 to October 2011. On these occasions, national home prices were 14 percent or more below current levels. However, since mortgage rates have so rarely been at these levels, looking at housing price history provides more data to consider.
  2. Housing prices. According to the S&P/Case-Shiller Home Price Indices, the average home price across 20 major U.S. cities was higher than it is now from September 2004 through May 2008. During that time period, 30-year mortgage rates ranged between 5.58 percent and 6.76 percent, so it is possible to have home prices higher than they are now at rates higher than current mortgage rates.
  3. A shock to the system. Perhaps the most striking thing about the recent rise in mortgage rates from a historical perspective is that because rates were starting at such low levels, it represented a steep rise as a percentage of borrowing costs -- mortgage rates were a third higher at the end of 2013 than they were at the beginning. You have to go back to the early 1980s to see a similarly drastic relative increase in mortgage rates. So, it may not be the level of mortgage rates, but how quickly they rose that the housing market is having trouble digesting.

The above suggests that the housing rally can survive current mortgage rates or even higher ones, as long as they do not rise too quickly. A slow and steady rise in mortgage rates might be tolerable for buyers and sellers who just want a stable market with fair prices, though it may not suit speculative investors looking for a quick gain.

This article The Trouble with Sharply Rising Mortgage Rates originally appeared on

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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