Implications of a 4.5% Mortgage RateJanuary 12, 2009
Submitted by David Boehmig, President/Founder.
We estimate that a decline in 30-year conventional mortgage rates to 4.5% on a sustained basis could increase housing affordability by 20% and thus housing demand by 2.8%, stabilize home prices, and would free up to $22 billion of disposable income (about 0.2%) annually for homeowners through refinancing of existing mortgages.
The policy prescription for the housing crisis and worsening consumer credit has been lower mortgage rates, with a widely held expectation that the target for a conventional 30yr fixed rate mortgage is 4.5%. The purchases by the Treasury and the GSEs and expected Fed purchases have indeed pushed mortgage rates lower. The mortgage market is now priced for high levels of refinancing (Please see The New Refinancing Wave: Shallower but Longer, December 17, 2008 for more details on market pricing of refinancing) and seems to indicate confidence that policy measures will succeed.
Lower Rates Will boost Housing Affordability by 20%
Home price declines have already increased housing affordability to multi-decade highs and lower mortgage rates will increase this further by 20% (Exhibit 1). This measure of housing affordability as created by the National Association of Realtors compares the mortgage payments on a home purchase at the median price for a family earning the median income. Note that the latest level of housing affordability from October is close to multi-decade highs even as it is calculated with a 6.23% mortgage rate. The impact of the lower mortgage rates post October has not shown up in the index yet. We estimate that the affordability index would rise by 20% with the mortgage rate down at 4.5%. This increased affordability should spur increased home purchases and provide a floor to home prices with the benefits flowing through to consumer confidence, consumer spending and credit as well as improved financial system health. An estimate by eminent economists Christopher Mayer and R. Glenn Hubbard of Columbia Business School shows that increased housing affordability with a 4.5% mortgage rate could spur as much as 2.2 million new home purchases even after assuming a worsening employment picture (the authors assume a 8.5% unemployment rate in their analysis). More details on the estimate can be found at their website : http://www4.gsb.columbia.edu/realestate/research/housingcrisis/mortgagemarket. The forecasted increased demand is 2.8% of the approximate 80 million units US housing market (based on US census data).
A sustained decline in mortgage rates to the 4.5% level could yield several benefits including potentially stabilizing the housing market, increase consumer discretionary incomes, credit and confidence as well as helping bank capital positions. Policy makers have signaled that they believe the cure for the current housing and the related credit crisis includes lower mortgage rates. In recent days, they have displayed their willingness and their resolve in that direction and the market seems convinced that they will succeed. The interplay between home prices and refinanceability is important, and initial success in stabilizing the declining housing market will lead to further success as increasing numbers of borrowers are able to refinance, increasing consumer discretionary income and confidence.
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