How will a declining housing market effect interest rates.?

Question

Will the decline slow the economy and cause the fed to lower rates which will then effect the prime rate that is used in mortgage calculations? Or am I way off?

Answer 1

I don't think the Fed is going to LOWER rates anytime soon. If you grab the Wall Street Journal and take a look at last year's numbers for the Fortune 500 companies, some reported highest profits since 5 years. This and many other signals are indicators of actual overheating on the economy.

As for the housing market, the interest rates are only projected to go up. Policy changes that contributed to the rise of housing prices in some areas was making it illegal to charge pre-payment penalties for residential housing loans. This makes sense since it is now cheaper for someone to buy a home since he will avoid interest expenses by paying off the principal amount early.

Second, is the new tax laws that are already in effect, and those that will come into effect, which are bringing the price of houses down. (1) Capital Gains tax has been revisited and now, any gain made on the sale of real-estate is now treated as a personal income item, which for most property, will be placed at the highest federal tax bracket (35%). (2) Tax exemptions for rent are to come into effect in some states as early as 2009. This will allow tenants to deduct a portion of their rent from their taxable income. This will place the tenant and landlord in conflict. The tenant will want to claim the actual amount he or she pays so that they may get a higher return, while the landlord will want to claim the lowest amount possible, so he may not pay high taxes. In effect, the landlord will end up having to claim the actual amount from each rental unit, which is good for society and the government, but bad for the landlord, since it means more annual expenses, and less income from each property.

Since, most property with an income is calculated by taking the annual net income and multiplying it by some factor, the price of houses will fall due to the net income being small, or even negative in some areas!

Furthermore, if you are an economist, you can look at the indifference curves for "One-Family Houses" v. "Cooperatives or Condos". The Co-Ops are actually an inferior good, which means, the more money you have, the less of it you want. They are also a Giffen good, which means that given a budget contraint, you will actually purchase more of them when prices go up (as long as they are within your budget, and the substitute is priced higher).

One-Family homes in New York go for as high as $1.5 million in some areas. In the same areas, the price of Co-Ops is $550k. Though the prices of One Family homes actually fell, the price of Co-Ops rose more than 17% since last year! What else rose? The amout of people actually buying these units.

As a result, spending on housing is allowed to continue, despite high prices for One-family homes. While the One-Family home market is declining, the Co-Op and Condo market is booming; keeping the housing market stable overall. So, the housing market will have little, if any, impact on the interest rates.

Instead, interest rates will be used as a tool by the Fed, to control consumption spending. If you take a look at Economic data for 2005-2006, the Fed is most likely going to raise rates to cut down on consumption spending. They have not done so yet, because there is huge military spending, and if consumption spending falls, income falls, tax revenue falls, and since tax revenue is needed now, tax rates might actually go up if the Fed decides to raise rates before this Iraq crusade is over. But once it is over, the Fed can quickly raise rates to prevent a serious recession in the near future!

Answer 2

NEW homes will be offered with more upgrades, such as marble counter tops in the kitchens, better appliances and fancier bathrooms.

If that does not help, the builders will offer "buy downs" such as a 3-2-1 buy down, where the first year, they pay 3% of the loan, the second year they pay 2% of the loan and the last year they pay 1% of the loan. However, if your loan is say 6% and you can not afford it, come the fourth year, you will be in a lot of trouble trying to make payments.

With both NEW and EXISTING homes, your realtor may send you to lenders that have low monthly rates to start and then around the five year point, the rate goes up. Again, if you can not afford the rate projected for five years from now, you could be in trouble.

Or you could be offered an adjustable rate with a nice rate to start but the only way it will go, unless we have a major economic crash, is up. Again, you could be in trouble.

If you want to buy a home and do not want to get burned:

First figure out how much of a down payment you can make.
Remember, if less than 20% you probably will have to buy mortgage insurance, which raises your rates.

Second, figure out how much you can afford in house payments. Remember, that includes principle, interest and escrow for taxes and insurance.

Third, keep in mind homes come with a bunch of utilities. If you have lived in an apartment you probably have not had to pay all the utilities. Also, many require a security deposit for first time customers. As a homeowner, you must have sewer, water, electricity and garbage pick up. You may also have gas, phone, cable and internet access.

Lastly, if you have been renting a new car every three years or buying and trading, you may want to consider buying a car coming off a 2-3 year lease and keeping it for 6-7 or more years. That way you get a relatively new car and not get stuck with the massive depreciation for the first few years. That will go a long way to helping you get a house.

Answer 3

Sounds like a possibility. They may lower interest rates to stimulate the economy but once the economy is stimulated usually they return to were the were or higher.