Interest rates, and their impact on the real estate market, have always fascinated me. I'm not sure of what the highest rates ever were on a 30 year mortgage. I do remember a time when the Veteran's Administration was quoting a rate of 17.5% on the purchase of a home in San Antonio, TX. If you were to acquire a loan of $81,787 at this rate the monthly principal & interest would be $1,199.00 per month. The same monthly payment at 6% equates to a loan of $200,000.
As you might expect, when interest rates were at the higher rates, there weren't a lot of buyers who could afford to purchase a home. The short term solution for this in San Antonio was the the issuances of a variety of buy down mortgages which had a more affordable initial interest rate in the 7 to 8% range. Buyers in the early 1980s were content with these buy down mortgages, even though they knew they would escalate to as high as 14% over the ensuing four years.
A curious phenomena during this time was that in spite of the certainty of the interest rates increasing at a rate of 2% per year over the next four years, sales prices were at an all time high. The values seemed to be dictated by the initial lower interest rate rather than what the rates would be when the buydown matured to a fixed interest rate. No one seemed concerned that the payment on a $150,000 mortgage at 7%, would increase by over $700 per month at maturity.
My thoughts at the time were that a very high percentage of the buyers of these buy down mortgages would not be able to afford the higher payments, and would either have to re-finance their loans sometime during the four year period when their interest rate was increasing, or sell their home. The only problem with latter solution was that in order for them to sell their homes, the values would have to increase significantly during this time frame. To re-finance, the fixed rate would have to stabilize at an affordable rate.
Well, neither of these solutions came about. As it turned out, the market prices in the early 1980s were highly inflated, and values tumbled in the mid-1980s as more and more homeowners, unable to re-finance their mortgage or to sell their homes, had no alternative but to accept the foreclosure solution. Homes purchased in the early to mid-1980s were selling at foreclosure for as much as 40% lower than their loan balance.
As history dictates, the real estate market recovered and interest rates became very stable, remaining in the 5.5% to 6.5% range for most of the current decade. At these generous rates, more buyers were able to afford home ownership, and subsequently, home prices in San Antonio reached an all time high after an article in a national magazine forecasted San Antonio as the best city in the country in which to purchase a home.
Whether the San Antonio real estate market would have continued to flourish if it hadn't been for the current lending debacle that has crippled our economy, is questionable. My thoughts are that home values would have increased beyond their true value and we would have had a subsequent decline in values. It's all about supply and demand and affordability. And this, as always, will be dictated to a large extent by the current interest rates.
To read other articles by Ed Barrett, go to www.EdBarrettHomefinder.com