When interest rates are up, home values go down.  When interest rates go down, home values go up.  That’s a basic principle, but I do agree with those who expect this market to perform counterintuitively to stablize prices vs. causing them to go up.  Basically that means they go up to where they are, counteracting the continued pressure for them to decrease. (see 5th paragraph below)

In 1990 when I started in real estate, the common walk-in client said “I want to buy a 4 bedroom, 2.5 bath colonial, with a basement and a monthly payment of $1,200”.  Let’s set the bogey at double that and toss out the basement 🙂  The number I hear most often for the neighborhood below is a rental payment of $2,500 a month or a mortgage payment of $3,000 or so with 20% down. (talking SFH Redmond here)

I like using Abbey Road in Redmond as the bogey house.  Kind of like Goldilocks and the Three Bears selection process.  Not too big, not below desirable…just right.  Good schools.  Popular neighborhood;  3 car garage most times. Current median price around $700,000.  Range of pricing from $630,000 to $830,000.  Not too new to be affordable, not too old to be acceptable.

Let’s test the theory with a monthly payment of $2,800 a month not including taxes and insurance which would add about $500 a month to the payment, and using 20% down (see next post for ratio of value to total mortgages of the neighborhood). Let me test that against $3,000 net after tax payment.  The after tax benefit should be about $700 minimum, so $2,800 plus $500 = PITI of $3,300 less $700 gives plenty of breathing room for price to go up to $750,000 or for people to stick at $650,000 if their household income is $100,000 vs, $150,000.  Depends on whether you use 28% or 33% for housing payment.  At 33% of $100,000 you would need about $200,000 down on the $650,000 purchase price.  Fits the basic buyer profile for that area anyway you slice it.

Rates of 6.25% and 20% down and a payment of $2,800 P & I,  would equal a sale price of $570,000.  Current prices would continue to be drawn down toward $570,000 at rates of 6.25% even in a seller’s market (which this neighborhood still is) due to financing qualification changes. Someone asked me from Sunday Night Stats why prices are continuing to go down in Seller’s Market neighborhoods.  That’s your answer.  Qualifying guidelines & interest rates reducing the ability to purchase and pressuring prices downward.

Now let’s change the rate from 6.25% to 4.5% and see what happens to sale price.  Keeping the same monthly at $2,800 and 20% down at 4.5% the sale price would be $690,000. 

So, my gut was right.  As rates go down to 4.5%, it does not increase the price from the $700,000 bogey we started with, but it does stablizes home prices and keeps them from slipping further down.  I always work through these things in my head in real time, testing my perception against reality.  I’m always happy when I prove myself right, and admittedly sometimes scratch the post if I prove myself wrong by the end of the post :).

I test the same theory on Rivertrail Townhomes with a bogey of $1,800 a month P & I.  High end I won’t calculate…and clearly not at 20% down.  I can’t realistically do townhome scenarios until FHA rates get lower.  But the $700,000 give or take single family home market will clearly be supported in value by interest rates of 4.5% preventing prices from slipping further back.

So to answer Jillayne’s question on my Sunday Night Stats post (sorry for the delay, Jillayne; had to test my answer) the 2nd wave of Alt-A’s will not affect pricing in this scenario IF 4.5% interest rates take hold, counter-acting the negative impact.

Sorry for the long drawn out answer to Jillayne’s question, but I don’t answer off the top of my head, even when I think I know the answer in two seconds.  I test my answer first…and this one tests out in this example.  FHA won’t test out, I’m not even going to try to test it out.  Unless FHA rates get much lower, the middle value market is going to win on all fronts.  High end will continue to suffer from Jumbo Loan issues.  Low end will continue to suffer from cash to close issues unless FHA rates come down substantially and toward at least 5% or less.  FHA and VA rates were conspicuously missing from Rhonda’s Friday rate post…  Maybe she can pop her head up from her busy day and catch us up on where those rates are, or at miniumum include them in this week’s Friday Rate Post.

Bottom line…4.5% interest rates will stop property values from declining…at least in my service area of North Seattle and Eastside.  Someone else will have to test the theory in the South End of Seattle and beyond, and for the rest of the Country.