This is an major update to a post written in February, 2020. Here, I’ve added a new graphic which takes into account that interest rate changes have smaller impacts on monthly mortgage payments when, 1) there are down payments, and when, 2) we take into account that monthly mortgage payments are made up of more than just principal and interest payments. I think this new graphic more accurately represents the impact of interest rate changes on the real monthly mortgage payment price of houses. Although this post was updated in January 2021, I’ll constantly update the graphics below monthly with the latest data available. – John Wake

How have 30 years of falling mortgage rates changed the economics of homeownership? The answer shocked me and changed my view of how the real estate market really works.

At the end we’ll compare how it affected Baby Boomers versus Millennials, but first let’s start with the conclusion and then I’ll explain how I got there step by step.

Real Mortgage Payment-Adjusted House Prices Since 1990

Conclusion

Take the Case-Shiller House Price Index

  • Adjust It for Inflation
  • Adjust It for Mortgage Interest Rates

Keep in mind that in January 1990 the Savings & Loan real estate bubble was peaking, or had already peaked, in most metropolitan areas. 1990 wasn’t a typical year at all. The S&L bubble hit the Northeast and the West Coast the hardest.

Case-Shiller Home Price Index

Now it’s 2020, so let’s see what’s happened to nominal house prices since 1990.

A few different house price indexes are out there. The S&P CoreLogic Case-Shiller Home Price Index is probably the most well known. It’s my favorite. They publish data on house price appreciation for 20 cities and the USA every month. The Case-Shiller Index is based on nominal house prices. 

Case-Shiller uses a price index instead of actual dollar prices which has advantages and disadvantages but it does make it easier to see price changes over time and, especially, to compare price changes over time between the 20 cities they cover.

The index doesn’t capture changes in prices due to houses getting bigger. It’s based on how the prices of individual houses change over time.

Their baseline year is 2000 but using a little math we can shift the baseline year back to 1990 so it’s easier to see the whole story of house prices unfold over the last 30 years. Case-Shiller only has data back to 1990 for 17 of its 20 cities, so when we shift the baseline year back to 1990, Atlanta, Dallas and Detroit drop out.

Case-Shiller Adjusted for Inflation

The Case-Shiller Index is based on changes in nominal prices. We want to see real, inflation-adjusted house prices over the last 30 years.

There are a few ways we can adjust for inflation. Probably, the most common way is to use the Consumer Price Index (CPI). Among the consumer price indices, probably the most commonly used is the CPI-U, the Consumer Price Index For All Urban Consumers. Since Case-Shiller itself directly measures home price inflation, it’s better to use a deflator that doesn’t also incorporate housing price changes, so I use “CPI-U Less Shelter” as the deflator.

I applied the CPI-U Less Shelter to the Case-Shiller Index to get an inflation-adjusted house price index. I much prefer to see the real, inflation-adjusted index whenever I’m looking at house price changes over more than a few years time.

First, in the graph below, let’s compare the nominal Case-Shiller Index to the Inflation-Adjusted Case-Shiller Index.

Next, let’s compare the Inflation-Adjusted Case-Shiller Index for all the metros they follow back to 1990.

The shocking truth is that real, inflation-adjusted house prices haven’t skyrocketed in all metro areas.

Adjusting house prices for inflation makes the graph a lot more realistic but we’re still missing a huge factor. 

Mortgage interest rates have fallen a ton since 1990 and that greatly reduced the monthly mortgage payment price of houses… at least in the short and medium term.

Two Prices for Every House

It’s like we have two different prices for every house.

  • Cash Price
  • Monthly Mortgage Payment Price

Cash Price. If you’re paying all cash when you buy a house, then obviously the sales price is the price you’re paying for the house. The graph above of the inflation-adjusted price index does a great job of showing you how the real cash sales prices have evolved since 1990. 

Monthly Mortgage Payment Price. But when you’re borrowing money to buy a house like most buyers – especially first-time homebuyers – then the price you’re paying is less about the Cash Price of the house and a lot more about the Monthly Mortgage Payment Price of the house. It’s about how much monthly mortgage payment you can afford.

Most house buyers pay a mix of the Cash Price and the Monthly Mortgage Payment Price. If you’re putting 5% down as a down payment, then you’re only paying 5% of the price of the house at the Cash Price and 95% of the price at the Monthly Mortgage Payment Price.

To see what house prices looked like to people who are borrowing the money to buy their houses, I needed a graph that converted the Cash Price into the Monthly Mortgage Payment Price.

Interest Rates & Monthly Mortgage Payments

When mortgage rates fall, monthly mortgage payments fall even if the cash price doesn’t. How much do monthly mortgage payments fall when mortgage rates fall? 

I converted mortgage rates into an index of monthly mortgage principal and interest (P&I) payments. The base of the index is the first week of 1990, therefore, all the readings show what the monthly P&I payment per dollar borrowed would be relative to January 1990. 

The 30-year fixed-rate mortgage rate was 9.8% the first week of January 1990 (although the rate was above 10.0% for most of 1990). For the first week of January 2020, it was 2.7%. What does that difference mean for your monthly mortgage payment?

Hover over the index line for January 2021 and you’ll see that – dollar for dollar – the monthly principal and interest mortgage payment in January 2021 was only 47% of what it was in January 1990. That’s how much mortgage rates going from 9.8% to 2.7% affected the monthly principal & interest payment of houses per dollar of mortgage amount borrowed.

Case-Shiller Adjusted for Mortgage Rates

Now let’s adjust the Case-Shiller Index for changes in monthly mortgage payments due to changes in average mortgage rates so we can see how the Monthly Mortgage Principal & Interest Price Index has changed over the last 30 years. The impact is huge.

I used the 30-year mortgage rate for every week since 1990 to calculate what the monthly payment would be per dollar borrowed and then created an index of monthly mortgage P&I payments with the baseline being the first week of 1990. 

Nice. But the graph doesn’t take into account inflation and we saw earlier the huge impact inflation has on the nominal cash price of houses over time.  

Case-Shiller Adjusted for Inflation & Mortgage Rates  

To see what’s really happening to the monthly mortgage P&I payment price of houses, let’s adjust the Case-Shiller Home Price Index for BOTH inflation AND mortgage rates to get a mortgage P&I payment adjusted real house price index.

We’ll look at it 2 ways. First, we’ll convert the real cash prices into monthly principal & interest payments prices. Then, to make it more realistic, we’ll adjust for down payment amounts and the fact that principal & interest aren’t the entire mortgage payment.

Real Monthly Principal & Interest Price

The shocking truth is that Real Monthly Principal & Interest House Prices are lower today than in 1990 for the U.S. and in most metro areas.

Remember, if house prices were crazy high in a metro in January 1990 (for example, in California), then an index value of 100 equals crazy high house prices. In the three years leading up to January 1990, home prices increased almost 70% in Los Angeles, according to the Case-Shiller Index.

Also remember the index doesn’t reflect changes to house prices caused by increases in the average size of houses from 1990 to 2020. The index is based on how prices of individual houses have changed over time. It doesn’t show the changes in prices of the average or median house in the metro, it shows the changes in prices of “equivalent” homes from year to year.

Visually, the Real Monthly Principal & Interest House Price Index seems to me to explain the housing market better than the unadjusted Case-Shiller Index.

Real Monthly Mortgage Payment Price

The graph above does a great job of showing you the huge impact interest rates but it overstates the impact for two reasons.

  1. In the real world, people usually make down payments. The larger the down payment, the lower the monthly mortgage payment. The lower the monthly payment, the smaller the price reduction when interest rates fall. So, the larger the down payment, the smaller the impact of mortgage interest rate changes.
  2. And more importantly, monthly mortgage payments are made up of more than just principal and interest payments. Monthly mortgage payments include property taxes and insurance, and property tax and insurance payments don’t fall with interest rates.

My estimate is that property taxes and insurance typically account for 15% to 35% of mortgage payments, depending on how high property taxes are in the state. Principal & interest payments make up the rest and that part of the mortgage payment falls with lower interest rates.

The graph below takes both of those factors into account to better estimate how lower mortgage interest rates impact the real monthly mortgage payment prices of houses.

Take the Case-Shiller House Price Index

  • Adjust It for Inflation
  • Adjust It for Mortgage Interest Rates

The shocking truth is that Real Monthly Mortgage Payment House Prices are lower today than in 1990 for some U.S. metro areas.

Get a view of real house prices through the lens of monthly mortgage payments for all those homebuyers who borrow most of the money to buy their houses. 

Total Mortgage Debt

Lower rates, however, eventually lead to higher house prices and more future mortgage debt. 

Total U.S. mortgage debt on single-family houses is quadruple today what it was in 1990. Adjusted for inflation, it’s double. The U.S. financial sector is far larger today than in 1990 due in part to the growth of U.S. mortgage debt.

Millennials vs. Boomers

Who had it better, Baby Boomers 30 years ago with much lower house prices and much higher mortgage rates, or Millennials today with much higher house prices and much lower interest rates?

Looking at the Real Cash Price, Baby Boomers had it much better but looking at the Real Monthly Mortgage Payment Price, Millennials have it much better today in many places.

One thing for certain about buying a house in 2020 versus 1990 is that mortgage rates aren’t going to fall like they have the last 30 years. 

Baby Boomers

The decades of falling mortgage rates helped Baby Boomer homeowners in two different ways;

  1. The falling mortgage rates caused house prices to increase a lot which caused Boomer wealth to increase a lot, and at the same time,
  2. Boomers could refinance into the lower rates, lowering their monthly mortgage payments.

Increasing wealth and decreasing expenses! Nice combination, all thanks to lower mortgage rates!

Millennials

But as rates fell, people could — and eventually did in most metros — pay a lot more for houses. The lower mortgage rates got monetized into higher house prices.

The shocking truth is Millennials in 2020 have lower Real Monthly Mortgage Payments than Boomers did in 1990 for the equivalent house in many areas. The Real Cash Price, however, is much higher in 2020 and Millennial mortgage debt is shockingly high. Because they have so much more debt, fewer Millennials will be able to pay off their mortgages early. Millennials have more debt, longer.

And Millennials definitely won’t have the Boomers’ tailwind of decades of falling mortgage rates. Millennials won’t see decades of increasing family home equity wealth and decreasing monthly mortgage payments due to falling mortgage rates like the Boomers did. 

Millennial Inflation?

It doesn’t seem likely but it’s not inconceivable, however, that Millennials could see a different kind of tailwind. The first-time homebuyers of the World War II generation, for example, benefited in a way that the Baby Boomers didn’t. The rocketing inflation of the 1970s was, in one way, a big break for World War II generation homeowners. The high inflation caused their fixed monthly mortgage payments to shrink fast in real, inflation-adjusted dollars. The U.S. dollar in 1980 was about half the value of the U.S. dollar in 1970. 

Of course, the high 1970s inflation that helped the World War II generation homeowners ended up forcing the Baby Boomers to pay crazy high mortgage interest rates in the 1980s and beyond.

If, perhaps, inflation increases more than expected in the 2020s, Millennial homeowners could end up following in their grandparents’ footsteps a little bit while leaving Gen-Z or the next generation to cope with the higher mortgage interest rates that would follow.  

OK, Boomer… and Millennial, Remember Gen-X

Boomers and Millennials weren’t the generation hardest hit by the Great Real Estate Bubble. Most Boomers had already bought their first houses long before at lower prices and most Millennials were still in high school or college.

The generation hurt the most by the Great Real Estate Bubble was by far Gen-X. Many Gen-Xers were set back many years financially by the real estate bust and most did nothing wrong. Their only mistake was hitting first-time home buyer age at the wrong time.

But the Gen-X story is depressing so after the real estate bust their story was buried. Sad stories are bad for business. The real estate industry instead moved on and talked non-stop about the positive impact Millennials would bring to the market when they hit first-time homebuyer age.

Since the bust, how many real estate stories have you read about Millennials? How many have you read about Gen-Xers? In real estate, Gen-X is the forgotten generation.

Equation for Calculating Monthly Mortgage Payments

Equation for calculating the monthly principal and interest mortgage payment on a 30-year fixed-rate mortgage.

P = M* [ (r/12)* ((1+(r/12))^360) / (((1+(r/12))^360)-1) ]

    P = Monthly principal and interest mortgage payment

    M = Mortgage amount borrowed

    r = Annual mortgage interest rate

360 is the total number of monthly payments for a 30-year mortgage.

Example. If the amount borrowed was $100,000 and the annual interest rate was 4.0%, then the calculation would look like this:

P = $100,000* [ (0.04/12)* ((1+(0.04/12))^360) / (((1+(0.04/12))^360)-1) ]

P = $477 would be the monthly principal & interest mortgage payment on a 30-year, fixed-rate mortgage of $100,000 that had a 4% annual interest rate.

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