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Three Cents Worth: Mortgage Rates, Sales Prices, Toothpaste

[This week, numbers wizzard Jonathan Miller examines the relationship between mortgage rates and Manhattan sales prices. And then, just when you think you've got it all figured out, he throws inflation into the mix. Stay sharp, people. The graph below shows the 30-year fixed mortgage rate (blue line) and the average Manhattan sales price (red bars) from the first quarter of '89 to the third quarter of '05. The y-axis runs from 0 to 12% for rates and to $1.4 million for sales prices.]

Mortgage rates tend to have an inverse relationship with property values because each determines the amount of monthly payment a buyer can afford. Playing this relationship is not exclusively a game for buyers. Sellers understand this relationship too. Lower mortgage rates create more buying power for purchasers (and more competition between purchasers for the same property) driving prices upward. In theory, the housing payment should remain about the same at the end of the day, with the lower mortgage costs offset by higher prices. (However, this is only theory-- in fact, housing payments as a percentage of disposable income have increased over time as personal income gains have not kept pace with housing prices.)

This chart clearly shows the relationship between these two variables in the purchase equation. Since 1989, the 30-year fixed rate has trended downward while the average sales price has trended upward. Price appreciation became more pronounced in 1997 as the late 1980's oversupply was finally absorbed and very little housing stock was being added to the market. For perspective, mortgage rates today are nearly half their 1989 levels and remain at 30-year lows. Meanwhile, average sales prices are almost triple their 1989 levels.

Today inflationary pressures like rising energy costs and the growing federal deficit will be a primary concern over the next several quarters. This could continue to push mortgage rates upward if bond investors get nervous. As noted in the recent issue of the Economist, the former president of the German Bundesbank once remarked that “inflation is like toothpaste. Once it is out of the tube, it is hard to get it back in again.”
· Average Sales Price vs. 30-Year Mortgage Rate [Miller Samuel]