The Real Role of Mortgage Rates

Because of lower mortgage rates you're able to get real estate financing at bargain prices today, according to a new chart from Freddie Mac. It's a cute chart and it's entirely accurate as far as it goes -- but does it go far enough?

First, let's take a look at the Freddie Mac chart.

mortgage rate table

The chart confirms what every mortgage shopper knows: lower mortgage rates equal smaller monthly payments for principal and interest. The chart also supports the historical record, the idea that mortgage rates have fallen from the inflated highs in the 1980's to the record lows in 2012.

Mortgage Rates and Changing Home Prices

But a more interesting question is this: Why compare $200,000 mortgages over the decades? Have home prices remained unchanged?

If we combine mortgage rates with median existing home prices for given years we get a more interesting comparison. The single-family home price data comes from the National Association of Realtors and the mortgage rates come from Freddie Mac.

mortgage rate table

Now we have a very different picture. It's still true that mortgage rates have fallen substantially from the 1980's but at the same time home values have also changed -- they peaked in April 2007 and today remain 8 percent below the 2007 high.

Monthly Mortgage Costs

If we imagine 100-percent financing at then-current rates for typical single-family homes we can get a better sense of monthly housing costs for mortgage principal and interest on an historic basis. Here are the numbers with 30-year, fixed-rate financing.

mortgage rate table

What the chart above shows is that housing costs -- on a cash basis -- are now closer to 1985 than to 2005. The catch is that we need to see housing costs in context, have they risen or fallen relative to household income? To get the median household income numbers we can look at the figures assembled by Dave Manuel (they are adjusted for inflation) and then see how the annual cost for principal and interest compares. Note that the household income figure for 2014 is an estimate.

mortgage rate table

Low Mortgage Rates Behind Today's Affordability

What do these numbers tell us?

First, the 2014 household income estimate reflects the fact that incomes have been falling since 1999. The last figure we have is for 2012, at which time median household income was $51,017.

Second, homes today are more affordable than a decade ago because of both lower mortgage rates and reduced home values.

Third, the impact of mortgage costs is over-stated in the sense that mortgage interest is generally tax-deductible, as are property taxes.

Fourth, while we have looked at interest expense and mortgage rates, there are other costs associated with housing, such as property insurance and property taxes.

The probability is that today you can own a home at a smaller relative cost than a decade ago, but you have to go back to the 1970's to find better affordability.

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