Housing Bubbles and Rent Ratios
Bruce Barlett observes that the Fed’s recent increases in the discount rate will increase the likelihood that the so-called “housing bubble” will burst.
As the Federal Reserve moves to raise short-term interest rates once again, flags are raised about the effect on housing prices. With housing being the largest household asset Ã¢€” and one that has risen sharply over the last several years Ã¢€” a downturn in housing prices akin to the fall in stock prices since 2000 would be devastating to families and the economy.
A key concern is that mortgage lenders now often lend to homebuyers with no money down. Until recently, they have usually demanded a 10 percent to 20 percent down payment before one could obtain a mortgage, in order to protect themselves from housing downturns. Further, many homebuyers now have adjustable rate mortgages, which rise automatically when interest rates rise, rather than fixed-rate mortgages that remain the same no matter what happens to interest rates.
Bartlett remains optimistic about the continued wisdom of home ownership:
Prudence suggests that it would be unwise to buy a house in the expectation of future price increases like those we have seen. However, those planning to stay put for a few years should not suffer. In any event, all homeowners would be well advised to get out of ARM’s and refinance into fixed rate mortgages as soon as possible.
Matthew Yglesias focuses on the disparity beween monthly mortgage payments and rental values.
If demand for home purchases is rising faster than demand for home rentals, it seems to me that that can only mean that people are buying houses as speculative commodities — spending more than the house is really worth to them in the expectation that it’s value will only increase in the future
As Matt’s commenters note, there are numerous non-economic reasons for buying a home. Still, off the top of my head, three major economic advantages exist for buying vice renting:
- A huge deduction on federal income taxes subsidizes the former. Thus, a somewhat higher mortage payment will be offset by the tax advantage.
- Hedge against inflation: One locks in one’s monthly payment when buying whereas rent continues to escalate. (Granted, insurance, utilities, and other costs will escalate.)
- Equity: Even if the price doesn’t appreciate, part of the money one pays monthly accrues as value (admittedly, a small part in the early years of traditional mortgages). If the house price does appreciate, that added value is also gained upon resale. Even if one buys again in the same housing market, this nets a huge down payment on the next, more luxurious home.
These advantages are offset somewhat by the increased expenses of owning a home–repairs, upkeep, added pressures to spend more money on decor and such–but not enough to make ownership a poor choice in most cases.
Still, like Bartlett, I’m concerned about the upward trend in interest rates. Those of us who live in very expensive housing markets tend to have more of our monthly income channeled into housing. A conventional mortgage, while secure, is generally a poor choice for those not intending to remain in a house for several years, since ARMs offer substantially lower initial rates and thus lower monthly payments and/or the ability to buy “more house.”