In the ongoing debate about housing affordability, interest rates have often taken center stage. However, a recent report from the Federal Reserve Bank of Dallas challenges the common belief that lower interest rates automatically translate to improved affordability. The report, based on data from the National Association of Realtors (NAR), suggests that the relationship between interest rates and housing affordability is more nuanced than previously thought.
According to the report, while lower interest rates can make mortgages more affordable, they also have an impact on house prices. When interest rates rise, house prices tend to decline, which can offset the benefits of lower borrowing costs. This means that changes in interest rates alone do not always result in improved affordability.
The study highlights the period from December 2021 to the present, during which interest rates increased from around 3% to nearly 7%. Despite this significant rise in rates, housing affordability actually declined by almost 30%, reaching levels not seen since the late 1980s. The rapid increase in mortgage payments contributed to this decline in affordability, despite the expectation that lower interest rates would make housing more accessible.
One key factor influencing affordability is the house-price-to-income ratio. Before 2000, this ratio was relatively low, supporting affordability. However, since then, rising house prices have led to a higher price-to-income ratio, making housing less affordable for many. Even without changes in interest rates, the report suggests that housing affordability would have declined due to the substantial increase in house prices seen post-pandemic.
The report also challenges the notion that monetary policy changes only affect interest rates directly. Indirectly, these changes can also impact house prices. For example, estimates from the San Francisco Federal Reserve Bank suggest that a 1 percentage point increase in short-term interest rates could lower house prices by 7.5% over two years. Conversely, if monetary policy had not tightened and mortgage rates had remained at their December 2021 levels, house prices would likely have risen even faster.
In conclusion, the relationship between interest rates and housing affordability is multifaceted. While lower interest rates can make mortgages more affordable, they can also influence house prices in ways that may offset these benefits. As the report from the Dallas Fed highlights, the net effect on affordability is ambiguous and may not always align with intuition based solely on changes in interest rates. Understanding these complexities is crucial for policymakers and individuals alike as they navigate the housing market.