The Relationship Between Home Prices and Mortgage Rates

November 29, 2012 No Comments »
The Relationship Between Home Prices and Mortgage Rates

Many people believe in the ol’ wives tale that a direct relationship exists between home prices and mortgage rates.

To be more specific, many believe in an inverse relationship between the two – that when one goes up the other goes down and vise versa.

The fact of the matter is, however, that a direct correlation does not consistently exist. Looking at any graph of the two side by side (see graph above) will show you there have clearly been years where they relate and years when they do not.

The best case I’ve heard arguing that a relationship does indeed exist is from econompicdata. Where they fault the leading research between the two variables (home prices and mortgage rates) is their misuse of ‘real’ prices vs. ‘nominal rates’ to compare the two – essentially disregarding inflation. Rendering it an apples to oranges comparison rather than apples to apples.

When you adjust both so that they are measured in real terms, a correlation between the two is slightly more visible, but there are still many contradicting data points with years of both increasing mortgage rates and increasing home prices as well as decreasing mortgage rates and decreasing home prices.

General Logic Concluding Zero Relationship

The general logic is this: Price is what someone is willing to pay for something and interest is a tool to finance an item. This is true whether it be buying houses with a mortgage, buying cars with an auto loan, or buying shoes with a credit card.

If credit card companies lowered rates on all of their credit cards, would all of your favorite clothing stores begin raising their prices. No.

There may be years when credit card rates become extremely low and retail goods see prices rise, but that doesn’t necessarily mean that one is happening because of the other.

If auto loan rates hit rock bottom do car manufacturers raise prices? No.

The same is said with home prices.

…Then Why the Myth?

In a nut shell – psychology.

They myth likely began when people began tracking these data points.  Given human nature’s predisposition to short term memory, the myth probably stemmed from a certain set of years where a striking inverse relationship occurred between the two. Rather than putting our suspicion to the test using historical data (or a lack of this historical data) we likely came to the conclusion that these two elements were tied together. What keeps the myth going is that every time this pattern shows up the myth then gets regurgitated into the present.

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