What if Mortgage Rates Went Back to the Future?

The Chicago Cubs' return to the Major League Baseball playoffs reminded several fans that in 1989, the movie Back to the Future Part II predicted that the Cubs would win the World Series in 2015. Movies about the future often have outlandish visions of what life would look like several years from now, but when that future arrives it often looks different than what was expected.

When Back to the Future Part II came out, a truly outlandish prediction – perhaps more so than the Cubs winning the World Series – would have been that mortgage rates would drop below 4 percent. After all, back in 1989, 30-year rates averaged 10.32 percent. As is often the case with time-travel movies, a subtle change can have profound ripple effects, and if mortgage rates returned to those 1989 levels, today's housing market would be very different.

Lower Mortgage Rates Soften the Effect of Rising Prices

The decline in 30-year rates from 10.32 percent to 4 percent is not the only aspect of the housing market that has changed since 1989. Home prices have also risen considerably. According to the S&P/Case-Shiller U.S. National Home Price Index, the typical house price has risen by 129 percent since 1989, far exceeding overall inflation since then, which has pushed consumer prices in general up by 89 percent.

Fortunately, this steep rise in home prices has been largely offset by the drop in interest rates. A $100,000 mortgage at the 1989 rate of 10.32 percent would cost you roughly $901 a month in principal and interest. Adjusting the size of that mortgage for the increase in home prices since 1989 would put the loan at $229,000. That increase would largely be countered by the interest rate dropping from 10.32 percent to 4 percent. The resulting monthly payment would rise to $1,093, an increase of just over 21 percent in terms of what the house would cost the borrower, in contrast with the 129 percent increase in prices.

How Would a Return to 1989's Mortgage Rates Impact Affordability?

Low interest rates have helped keep housing affordable despite the steep increase in prices over time. Without that drop in rates, a home would be much less affordable today than it was in 1989. Adjusting the mortgage to $229,000 to account for the increase in prices but assuming a return of rates to 1989 levels would result in a monthly payment of $2,064 – nearly twice as much as that mortgage would cost at today's rates.

It's not just potential buyers who would be affected if mortgage rates went back to 1989 levels. That steep rise in housing prices would probably not have occurred without such a large drop in interest rates. So, homeowners would have less equity in their homes today, and would receive less value when they sell. More buyer dollars would have to go towards paying mortgage interest, so less of that money could go towards the price of homes.

The Moral of the Story

No family blockbuster would be complete without a moral at the end, and there is a moral to this exercise in looking at mortgage rates taking a trip back to the future. Double-digit interest rates are not science fiction – they have happened within the lifetimes of most of today's adults, and they can happen again. This is a reminder that today's low interest rates are something highly unusual, and if they returned to previous levels it would have a profound effect on the housing market. The opportunity to buy a house as readily as you can today would likely be gone, and quite probably the opportunity to receive as much value when selling would also be diminished. So, those without a time-traveling DeLorean that might let them repeat this opportunity, now's the time to lock in these rare mortgage interest rates.

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