Falling mortgage rates should come with a warning: “Be careful what you wish for!”
This summer’s cheaper home loans have created excitement in the real estate market and suggest that California’s two-year homebuying slump may be coming to an end.
The Federal Reserve’s protracted battle with inflation – fueled by higher interest rates – has helped make buying a home in California nearly impossible for most homebuyers. But falling living costs and general economic lethargy starting in mid-2024 have already pushed mortgage rates down from their 20-year highs. The Fed is expected to begin cutting its benchmark interest rates in September.
Yes, lower interest rates are alleviating California’s enormous affordability problem. Some industry insiders even speculate that these savings could spark a rush to buy, driving California’s prices even higher.
But the same cheaper mortgages that prompt a “buy now” thought are often a sign of economic trouble. Remember, interest rates usually drop when the business climate cools.
In numbers
To visualize this mix of interest rates and prices, I populated my trusty spreadsheet with these statistics going back to 1977: the average 30-year mortgage from Freddie Mac, data on California home prices from the Federal Housing Finance Agency, and a number that may seem odd to you: the state’s unemployment rate from the Bureau of Labor Statistics.
Consider what we learn when we break history down into 12-month periods based simply on whether mortgage rates have become more expensive or cheaper over the past 47 years.
With an annual increase in mortgage rates, real estate prices in California rose by an average of 10 percent.
And then we look at what happens when mortgage rates go down. In California, prices only went up an average of 4.4%. Yes, less than half.
But let’s not blindly rejoice in rising interest rates. Think about a buyer’s theoretical payments on a home, using a calculation that takes these price patterns and interest rate fluctuations into account.
When interest rates rise over a year, estimated home payments in California increase by an average of 21%. More expensive homes and more expensive loans are a painful blow to the wallet. But buyers seem willing to pay more.
Conversely, during periods of falling interest rates, payments fell by an average of 2.6% per year. So it’s the cheaper money that makes California’s poor affordability possible.
From a traditional real estate perspective, these results may seem counterintuitive. But look at the economy from a broader perspective and think about the economic health of California’s labor market.
As mortgage rates rose over the past half century, unemployment across the state fell by an average of 0.7 percentage points per year. Generally speaking, when times are good and employers are hiring, rates rise.
Unfortunately, when the economy runs too hot – as we saw in 2021-2023 – the bond market and/or the Fed can play the Grinch, driving up interest rates and spoiling the economic party.
Compare this pattern to how the economy has performed over the past half century when lending rates have fallen: In California, unemployment rose by 0.3 percentage points. That means fewer jobs, lower demand for all kinds of goods and services – and a Fed that is more willing to help.
Bottom line
Don’t think too much about the sometimes short-sighted housing market data. It’s really about the three pillars of the real estate industry: “Jobs. Jobs. Jobs.”
Over the past 47 years, California home prices rose an average of 2% each year when jobs were scarce and unemployment rose. When unemployment fell, prices rose 9%.
Please note that unemployment in California has been above 5% for 10 months, after hitting a historic low of 3.8% in August 2022.
You see, a successful home search requires not only a salary, but also the certainty of keeping your job. And cheaper mortgages often go hand in hand with a weaker business climate and subdued consumer confidence.
This can cause California homebuyers to think twice about paying top dollar for a property. This is a major reason why prices drop when interest rates are low.
Of course, every cycle is different. Perhaps one or another real estate market will behave differently after the pandemic than the statistical norms that these calculations produce.
Think about the extremes of history. Prices rose 29% in the year to September 2004, amid lower interest rates. But cheaper mortgages could not prevent a 23% fall in the 12 months to September 2008.
So summer 2024 could be a “buy now” moment as falling interest rates help drive up California home prices. But the real catalyst would be an economy that makes an Olympic-quality soft landing with few job losses.
I also see from my spreadsheet that real estate prices in California have increased 67% of the time since 1977, when mortgages became cheaper within a year. Not bad odds.
However, when interest rates rose, prices increased in 85% of cases.
Addendum
The economic consequences of cheaper mortgages have varied slightly over the past half century depending on the magnitude of the rate cuts. Consider these examples of one-year rate cuts in California…
Interest rate reduction of half a percentage point or more: In these situations, housing prices increased by an average of 3.6% in 12 months. Again, this is a weak economy, as the unemployment rate in California increased by an average of 0.9 points in a year.
Deviation of three quarter points or more: Prices rose by 2.5 percent. Unemployment rose by 1.1 points.
From 1 point: Prices rise by 4.2 percent. Unemployment rises by 0.6 points.
Jonathan Lansner is a business columnist for the Southern California News Group. Reach him at [email protected].
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