Study Links Rise in Mortgage Rates to Falling House Prices in Many U.S Cities

RISMEDIA, August 19, 2008-New research by Christopher J. Mayer and Paul Milstein, professor of real estate and senior vice dean at Columbia Business School, shows that a rise in mortgage rates has had a significant negative impact on house prices throughout the U.S., reducing prices by more than 10%. Mayer predicts that prices will keep falling nationwide due to a combination of continued deterioration in the mortgage markets and economic fundamentals.

“The problems in the mortgage market have put the nation’s housing in a downward spiral that will be hard to break,” Professor Mayer said.

Examining house price data from 19 metropolitan areas in the U.S., Mayer determines the relative cost of owning a home in today’s distressed mortgage market, and compares this ratio to where prices would be if the mortgage market were behaving as it has over the last few decades. Mayer’s analysis shows that today’s higher mortgage rates have raised the full cost of home ownership by between 10 and 20%.

Mayer’s model suggests that housing markets across the U.S. will continue to decline as mortgage rates increase, including:

– “bubble” markets such as Miami, Tampa and Phoenix, where prices are likely to drop by at least another 10 to 15%;

– coastal markets such as San Francisco, Boston and New York, where house prices have corrected to where they should be based on economic fundamentals but are likely to keep falling due to deteriorating mortgage markets and broader economic conditions;

– hard-hit markets in the Midwest such as Detroit and Cleveland that have seen extremely high levels of foreclosures and face continued negative economic shocks; and

– more stable markets in Texas and the Carolinas that were not as affected by the subprime crisis or worsening economic conditions as other parts of the country, but are still likely to experience falling prices due to increasing mortgage rates.

When interest rates are low, as they are today, house prices are very sensitive to fluctuations in mortgage rates. For the last 20 years, mortgage rates have averaged at 1.6% above the 10-year Treasury rate, while in today’s distressed market these rates exceed the 10-year Treasury rate by more than 2.4%. Climbing mortgage rates make it more difficult for homeowners with subprime loans to refinance into lower rates, resulting in a greater number of foreclosures, and they discourage potential new homebuyers from entering the housing market, lowering demand. Both of these effects put further downward pressure on house prices.

For more information, visit www.gsb.columbia.edu.