Mortgage Rates and Affordability

Since the expiration of the tax credit, mortgage rates have dropped precipitously.

Palm Coast, FL – November 4, 2010Most home buyers and potential buyers in the last year were aware of the first-time home buyer tax credit. Most home buyers—nearly 80 percent—were also eligible for the credit. That opportunity for nearly all buyers has now ended; however, there is an exception for overseas military personnel and Federal employees. See the IRS’s First-Time Homebuyer Credit: Members of the Military and Certain Other Federal Employees for details if you think your buyer might qualify.

Home sales fell steeply in July after the credit ended, as shown in the figure below. Recent existing-home sales data shows that they have climbed back up through the end of September, and were only 14 percent below the June sales rate. Considering that many of these current buyers may have been tax credit eligible had they purchased a few months earlier, one might wonder why they are buying now.

Figure 1
Buyers’ Reasons for Purchasing
Survey data, found in NAR’s 2009 Profile of Home Buyers and Sellers, shows that among first-time buyers, the desire to own a home is the primary reason for buying. The responses vary more among repeat buyers, but the desire to own a home is still within the top 3. The second most commonly cited reason first-time buyers bought in 2009 was the affordability of homes. Again, responses are more varied among repeat buyers, but affordability was within the top 7 reasons. How has the expiration of the tax credit affected buyers from an affordability perspective?
Mortgage Rates and Affordability
Since the expiration of the tax credit, mortgage rates have dropped precipitously. The vertical line in the graph below denotes April 30, 2010, the last day for tax-credit eligible purchase contracts to have been signed. In that week, mortgage rates were 5.06 percent according to Freddie Mac’s weekly Primary Mortgage Market Survey. In the week ending October 21, mortgage rates, as measured by the same survey, were 4.21 percent—a decline of 85 basis points.
Figure 2
What has the decline in mortgage rates done to affordability? Falling mortgage rates alone were not enough to offset home price increases from April to June. However, affordability has increased as measured by the NAR Housing Affordability Index as a result of falling mortgage rates and some further softening in national home prices.
Figure 3
The Individual Buyer’s Payment 
What has this done to the individual buyer’s payment? Buyers who borrowed $100,000 at last week’s 4.21 percent rate instead of 5.06 percent paid about $50 less per month and more than $600 less per year. These buyers will see $8,000 in mortgage-rate-related savings within 13 years. Buyers borrowing more money for their home purchase will save more as a result of the easing of mortgage rates; a buyer who borrows $400,000 saves more than $200 per month and $2,400 per year, saving $8,000 in only 3 years.
Figure 4
As recently as 2008 mortgage rates were above 6.5 percent and in 2002 they were above 7 percent. The NAR Outlook currently projects a 5.9 percent mortgage rate by the end of 2012, but as history has shown us, mortgage rates can change quickly and they are strongly affected by policy as well as inflation and inflation expectations. (For an insider’s take on inflation check out the Economic Issues & Residential Real Estate Business Trends Forum with Lawrence Yun and Federal Open Market Committee Member Thomas Hoenig at NARdiGras in New Orleans or online at Conference Live!).
How might rising rates affect a borrower who takes out a $200,000 mortgage? The figure below compares payments in half-percentage- point increments in relation to a 4.5 percent rate. For each half-point increase in the mortgage rate, the extra monthly cost rises by $60, or more, and the annual cost increases by $720, or more.
Figure 5
©Copyright National Association of REALTORS®. Reprinted with permission.
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