What Happens to House Price Appreciation After Interest Rates Bottom Out?
First, let’s do a quick analysis of some numbers, and then let’s see what they might mean for future house price appreciation and family wealth creation.
In January 1990, the average interest rate on a 30-year fixed-rate mortgage in the U.S. was 9.9%. In December 2020, it was 2.7%.
With an interest rate of 9.9%, the principal and interest (P&I) payment is 0.89 cents per month per dollar borrowed. With an interest rate of 2.7%, the P&I payment is 0.41 cents per month per dollar borrowed.
The monthly P&I payment per dollar borrowed in December 2020 was less than half the cost in January 1990 due to the lower mortgage interest rate. Or, rather, with the same monthly P&I mortgage payment, you could borrow more than twice as much money to buy a house in 2020 compared to 1990.
House Price Appreciation
In January 1990, the Case-Shiller U.S. National Home Price Index was 76.527. In December 2020, it was 232.409.
That means a house that was worth $100,000 in January 1990 would have been worth just over $300,000 in December 2020, on average. According to this index, the average nominal U.S. house appreciated 200% from January 1990 to December 2020.
1990. The P&I payment on $100,000 at 9.9% interest would be $870 per month.
2020. The P&I payment on $300,000 at 2.7% interest would be $1,227 per month.
Although house prices appreciated 200%, monthly P&I mortgage payments only increased 41% due to the lower interest rates.
Certainly, if mortgage interest rates had remained at 9.9%, house prices wouldn’t have increased nearly as much from 1990 to 2020. But how much less?
How Much Less?
Let’s take the December 2020 P&I mortgage payment of $1,227 per month. If it had a mortgage interest rate of 9.9% like in January 1990, how much money could you borrow?
- A $1,227 per month P&I mortgage payment at 9.9% interest could buy a $141,000 house.
- A $1,227 per month P&I mortgage payment at 2.7% interest could buy a $300,000 house (in this simplified example without down payments).
That suggests if interest rates hadn’t fallen (but the P&I mortgage payment price stayed the same) that house prices would have only increased around 40% from January 1990 to December 2020. The rest of the 200% increase in house values was due to falling interest rates.
80% of Appreciation Due to Falling Rates
This quick analysis suggests that as much as 80% of the house price appreciation from 1990 to 2020 was due to falling interest rates. Without falling rates, home ownership would have created a lot less wealth.
For example, if you bought a house in 1990 for $100,000 and paid off the mortgage in 2020, you gained $100,000 in wealth by paying off the mortgage and $200,000 in wealth due to the appreciation.
If, however, mortgage rates had never fallen you would have gained $100,000 in wealth by paying off the mortgage and only around $40,000 in wealth due to appreciation, according to this quick analysis.
Future Appreciation Without Falling Interest Rates
It certainly seems that most of the house price appreciation over the last 30 years has been due to falling interest rates.
So what happens if interest rates have bottomed out and we don’t have falling interest rates pushing up house prices and family wealth over the next 30 years?
Could national house price appreciation the next 30 years be only 20% of what it was the last 30 years? Whatever the number, it seems extremely likely that real U.S. house price appreciation over the next 30 years will be a lot less than the last 30 years.
Scenario: A Lot Less House Price Appreciation
- Significantly less family wealth creation via home ownership.
- Significantly less family wealth creation overall.
- Paying off mortgages becomes a much more important part of family wealth creation.
- Savings and investment rates increase.
- Millennials will have significantly less home equity to draw on during their retirement years than Baby Boomers.
- Social Security becomes relatively more important for Gen-X and Millennials in retirement.
- Wealth inequality between homeowners and others will be greatly reduced over time.
- Foreclosure rates will increase since there will be less house price appreciation to help out homeowners hit with unexpected financial reversals.
- On the other hand, with slower appreciation, first-home buyers will feel less pressure to buy before they’re financially ready which will help reduce their future foreclosure rate.
- High foreclosure FHA mortgages become even higher foreclosure with slower house price appreciation. The negative effect increases exponentially as the percentage of FHA mortgages in a neighborhood increases.
- Greater downside risk to house prices. Typically, the Fed lowers interest rates before house prices can fall but what happens when rates have already bottomed out?
- House prices become more stable on the upside but more unstable on the downside.
- The trend toward building ever-larger new houses slows or, possibly, reverses.
- With less appreciation, demand from landlords falls and home ownership increases.
How to Prepare for Lower House Price Appreciation
Government policies should shift to promoting free-and-clear home ownership instead of promoting mortgage ownership at all costs, and assuming home ownership is a magic wand of wealth creation.
As paying off mortgages becomes a much more important source of family wealth creation, policies should reflect our new reality.
Step 1. Government-backed mortgages should be redesigned to maximize family wealth creation in a lower house price appreciation environment.
If we don’t, we could see family wealth creation tank, and a retirement crisis in 30 years or less.
What am I missing? What have I got wrong? Tell me in the comments below.
Notes. 1) The Case-Shiller Index is a repeat-sales index which means it looks at price changes for the same house, or constant-quality houses, or equivalent houses. 2) Keep in mind that January 1990 was near the top of the S&L real estate boom.
5 Responses to 80% of House Price Appreciation Since 1990 Was Due To Falling Mortgage Interest Rates?
Hey John, Love the analysis. My only comment is that the Fed is committed to an inflation target but can’t seem to achieve it. And the Govt. is committed to equality in home ownership and will lax ownership rules in the future (think 0 down again or govt. subsidized mortgages). Could we see negative interests rates over the next 5 years?…possibly. Also, the initial inflation will be a tailwind for housing prices. It’s only when inflation gets too high and persistent that it becomes a headwind for housing as interest rates will rise. I envision a decade or more of near zero or even negative interest rates before inflation starts to creep in (Michael Burry is wrong)…and even then, the initial effects of inflation will be positive for housing. I’d love to see a zero interest environment with inflation at 4-5% for two or more years. That should create another housing bubble before the Fed is forced to finally react to inflationary pressure (think Case-Schiller in the 600-700 range). That’s when I’ll sell. But I don’t see this playing out for another 7 to 12 years. So I agree with you. But I think your timing is off.
I like your stuff…keep up the good work!
weirdgoose, Cool comment. I don’t expect negative rates but I never thought rates would ever go as low as they are. Could mortgage rates hit 2%? 1%?
Stumbled onto your site. Keep up the good work. I never comment on websites but felt I needed to. The reports your putting out are so relevant and need to be seen by as many people as possible. How wonderful would it be if other Realtors were required or even desired to be as educated as you are on looking at the big picture of the greatest wealth creation Americans have, and that is real estate. I hope your clients realize how hard it is to find a educated relator and value what you bring to the table.
Did I miss the part where you accounted for wage inflation?
“Real” home prices are impacted by 2 factors, interest rates and household income. Households are fairly consistent in the percentage of household income they will allocate (either by their choice or limitations of mortgage guidelines) to a house payment.
Outside of price, the only 2 factors that significantly weigh on this calculation are rates, which impact the payment, and income which determine how much there is to allocate towards housing.
It appears you are crediting decreasing rates for home price appreciation without accounting for wage inflation.
Yeah, Right now I’m struggling with incorporating lower interest rates AND higher incomes. Whenever I do, it makes 2020 house prices look a LOT more affordable than 1990 prices for the same quality houses. Although 1990 was near the top of the S&L boom nationally.
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