How Interest Rates Affect House Prices
Written by The Landlord on 20 Jan 2008It’s said that the last housing crash in the UK, 1990-1995, was due to two main factors- low employment and record high interest rates. If people aren’t employed and interest rates are high, how will people buy houses or pay their mortgage? They can’t.
I was specifically interested in how the Bank of England Base rate affects the national stats for housing prices. I’m sure there are loads of other complicated factors that affect house prices, but I think it’s fair to say that interest rates is one of the heavyweight contender’s. Why? Because interest rates determine how much money we will have to spend on a monthly basis on our mortgage.
I’ve plotted two sets of data into one graph to view the correlations. The red line is showing the Bank Of England base rate from 1985-2007 and the yellow line is showing the average house price in the UK, 1985-2007, according to Nationwide, one of the Uk’s leading mortgage lenders. Nationwide get their data from the amount of mortgages they approve.
The lines are pretty symmetrical, showing that when interest rates are high, house prices drop and vice versa. If interest rates shot up to 15% in the current market, as they did in 1990, would house prices drop? I believe so. People are struggling to pay mortgages now, with a rate of 5.5%, let alone 15%. Funny thing is, people think that interest rates are high at the moment.
Anyways, are the results surprising? Not really. But you know, it’s good to see the proof with your own eyes. I tried looking for a similar graph, but Google failed to deliver. Or perhaps I’m just bad at Google.
You can see the raw data for this graph here, Nationwide Average House Prices Vs Base Rate.
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5 Comments - join the conversation...
The Landlord2008-01-24 13:11:41
Hey John,
Many thanks for the comment.
Unfortunately the graph doesn't directly show how the value has changed in money. I'd probably need a line showing average salaries in the graph to get a good idea of that. I'll see if I can get a hold of that data.
The purpose of the graph was merely to show me what the correlation between interest rates and house prices looks like, as opposed to show how much the value of houses have increased by.
As you said, the results are pretty obvious, but I just wanted to see for myself how much of a correlation there is. It's a lot clearer through a graph :)
Many thanks for the comment.
Unfortunately the graph doesn't directly show how the value has changed in money. I'd probably need a line showing average salaries in the graph to get a good idea of that. I'll see if I can get a hold of that data.
The purpose of the graph was merely to show me what the correlation between interest rates and house prices looks like, as opposed to show how much the value of houses have increased by.
As you said, the results are pretty obvious, but I just wanted to see for myself how much of a correlation there is. It's a lot clearer through a graph :)
2
john bull2008-12-08 00:51:14
7% seems to be an optimum interest rate. I don't see much sense in it being outside the 5-10% range in normal stable circumstances.
I can certainly remember how hard 14% was back in 1990!
Clearly we've got a divergent phugoid going on, and the long term consequences of that beyond this recession to a following even larger recession don't bear thinking about.
The idea that you don't apply interest rate "phugoid damping" to growth as well as recession is utter madness.
What I don't get is why did IngSoc drop interest rates in 2001?!
Simply saying "9/11" is not really a proper explanation; it seems that the drop in '99 followed by that sent the system into runaway oscillation.
I can certainly remember how hard 14% was back in 1990!
Clearly we've got a divergent phugoid going on, and the long term consequences of that beyond this recession to a following even larger recession don't bear thinking about.
The idea that you don't apply interest rate "phugoid damping" to growth as well as recession is utter madness.
What I don't get is why did IngSoc drop interest rates in 2001?!
Simply saying "9/11" is not really a proper explanation; it seems that the drop in '99 followed by that sent the system into runaway oscillation.
3
Pete2009-04-12 04:35:12
Unfortunately you are linking some things that are only partially related.
I will explain very briefly:
- BoE base rate made banks lend more. This is exactly what was happening in the US, post tech-bubble.
- The BoE drop in rates was to fight the tech bubble recession. They really messed up by leaving them low, as did the US.
- Due to the BoE low rates, credit was 'artificially' cheaper. Banks started lending it competitively. 100% loans, etc.
- Banks started creating complex securities like MBS and plaing with CDSs, meaning mortgage lending got even more out of control.
- All the financials (and insurers, eg AIG) started getting into the game."Make big money quick". The risk appeared low, but was disguised by the complex securities and their dodgy AAA ratings.
- Now BoE cannot do anything, their rate is 0.5%, but when inflation hits (see BoE money printing, aka 'quantitative easing'), the banks will be forced to hike up their rates to fight inflation. If you were a bank, would you lend at a rate less than inflation? This is important.
Remember...banks set their own interest rates. BoE sets it's interest rate that only partially affects the banks. Ultimately they make their own decisions on rates, and now they are going to be less happy to spend.
Your graph makes a bit of sense...BUT if you look at it in the following 10yrs (2019) you will not be able to draw the same correlation. This is because house prices will plummet, whilst BoE rates remain very low. This is because BANK interest rates will soar.
So, ultimately you are ALMOST right in that rates correlate with prices (sort of), but it is the banks rates that correlate, not the BoE rates. The BoE rates MAY (and did) cause the banks rates to drop...until 2009. There is a correlation, but not complete causality (at least not into the future).
A more basic and true equation is:
Credit Availability & Servicability affects House Price.
Availability and Servicability is both the willingness of banks to lend (and how much), including LTV ratios, and whether people can afford to pay the loan due to wages and interest rates. Eg Middle income earners cannot pay for a $1mil house at 15% interest.
Hope that helps, email me if you want clarification on anything or think I am full of it.
I will explain very briefly:
- BoE base rate made banks lend more. This is exactly what was happening in the US, post tech-bubble.
- The BoE drop in rates was to fight the tech bubble recession. They really messed up by leaving them low, as did the US.
- Due to the BoE low rates, credit was 'artificially' cheaper. Banks started lending it competitively. 100% loans, etc.
- Banks started creating complex securities like MBS and plaing with CDSs, meaning mortgage lending got even more out of control.
- All the financials (and insurers, eg AIG) started getting into the game."Make big money quick". The risk appeared low, but was disguised by the complex securities and their dodgy AAA ratings.
- Now BoE cannot do anything, their rate is 0.5%, but when inflation hits (see BoE money printing, aka 'quantitative easing'), the banks will be forced to hike up their rates to fight inflation. If you were a bank, would you lend at a rate less than inflation? This is important.
Remember...banks set their own interest rates. BoE sets it's interest rate that only partially affects the banks. Ultimately they make their own decisions on rates, and now they are going to be less happy to spend.
Your graph makes a bit of sense...BUT if you look at it in the following 10yrs (2019) you will not be able to draw the same correlation. This is because house prices will plummet, whilst BoE rates remain very low. This is because BANK interest rates will soar.
So, ultimately you are ALMOST right in that rates correlate with prices (sort of), but it is the banks rates that correlate, not the BoE rates. The BoE rates MAY (and did) cause the banks rates to drop...until 2009. There is a correlation, but not complete causality (at least not into the future).
A more basic and true equation is:
Credit Availability & Servicability affects House Price.
Availability and Servicability is both the willingness of banks to lend (and how much), including LTV ratios, and whether people can afford to pay the loan due to wages and interest rates. Eg Middle income earners cannot pay for a $1mil house at 15% interest.
Hope that helps, email me if you want clarification on anything or think I am full of it.
4
John Bull2009-04-14 10:06:43
I agree that the reason for the low rates was to do with the tech-bubble/asian financial crisis; and that keeping them low was silly...
...which was my point; i.e.: I think rates should *never* be put that low; too much jiggling about doesn't inspire much confidence either.
I think that there was such a goldrush mentality that decisions were driven by emotion (wanting to be the first on the internet train); and that is the core problem.
...people start believing in the possibility of a financial perpetual motion machine - I even remember a former boss confidently stating that "of course you can have perpetual growth" (what!?).
"Credit Availability & Servicability affects House Price."
Well yes, and it's the p2e ratio graphs that show the divergent phugoid most clearly.
...I would add "Confidence" into that equation:
it's not just a matter of whether the wages cover repayments; it's also whether you think the tide is coming in or going out before jumping in your dinghy.
Apart from my own belief that the bottom is most likely to be around 2016; I was wondering whether there was one more oscillation (i.e.: boom-bust) in the system, which would make for a terrifyingly huge boom in the 2020s... having seen the divergent phugoids on Merrill Lynch and friends, I now wonder whether this is the final oscillation - it seems a bit premature because the other factors: energy/oil costs have yet to enter the terminal price ramp we should expect in the 2040s.
Whilst house prices may drop about 25% over the year; there's a lot further they can go to return to median trend prices; and the whole unemployment thing has yet to play out.
There seems plenty of potential for a 7-10 year depression... dragged out by a collective sense of denial about the impossibility of perpetual growth; and the unsustainability of global-industrial-isation (i.e.: the jobs that get exported remove customers for the products that the exported jobs produce).
I think it stems from a banal Huxleyan notion that we could have a totally university-educated Benetton-ised society in blissful high-tech productive harmony importing low-tech goods from the extra-Atlantean world.
That's why I suggest that a narrower "bandwidth" for interest rates (5-10%) would reduce the "oscillation", (or correlation) that the graphs seem to show.
...even from the graph, you can see a zone of stability within those limits (at about 6%).
Around 2001, rates fall below that range, and prices begin to inflate; rates are then swiftly returned to 6% and prices stabilise; then rates are dropped out of that range until the present and as you observe - off they go into the stratosphere!
Banks need to make some money off it ...that's their revenue stream; the BoE ought to wop up rates to 10% ASAP, and burn off the rot of loans that should never have been issued (but obviously the regime don't dare), and let them drift down to 6% over 5 years, and hold them there for another 5 years (I'm not a Stalinist! but a bit of reliable forward planning would probably help). There needs to be a return to the old "3-times-your-salary" rule as a legal limit in order to rein in the lunacy (and inflation); as well as a moratorium on immigration (including EU); and a part-nationalisation of property to mop up all those defaulted mortgages that would accrue under such a policy... sadly, there's little chance of any leader with vision and guts to squarebash the country into shape ...so I predict a rough ride and protracted denial, with bouts of mild rioting and electoral "surprises" as heightened public expectation goes dramatically unmet... anyone still got their "Things Can Only Get Better" CDs?!
...which was my point; i.e.: I think rates should *never* be put that low; too much jiggling about doesn't inspire much confidence either.
I think that there was such a goldrush mentality that decisions were driven by emotion (wanting to be the first on the internet train); and that is the core problem.
...people start believing in the possibility of a financial perpetual motion machine - I even remember a former boss confidently stating that "of course you can have perpetual growth" (what!?).
"Credit Availability & Servicability affects House Price."
Well yes, and it's the p2e ratio graphs that show the divergent phugoid most clearly.
...I would add "Confidence" into that equation:
it's not just a matter of whether the wages cover repayments; it's also whether you think the tide is coming in or going out before jumping in your dinghy.
Apart from my own belief that the bottom is most likely to be around 2016; I was wondering whether there was one more oscillation (i.e.: boom-bust) in the system, which would make for a terrifyingly huge boom in the 2020s... having seen the divergent phugoids on Merrill Lynch and friends, I now wonder whether this is the final oscillation - it seems a bit premature because the other factors: energy/oil costs have yet to enter the terminal price ramp we should expect in the 2040s.
Whilst house prices may drop about 25% over the year; there's a lot further they can go to return to median trend prices; and the whole unemployment thing has yet to play out.
There seems plenty of potential for a 7-10 year depression... dragged out by a collective sense of denial about the impossibility of perpetual growth; and the unsustainability of global-industrial-isation (i.e.: the jobs that get exported remove customers for the products that the exported jobs produce).
I think it stems from a banal Huxleyan notion that we could have a totally university-educated Benetton-ised society in blissful high-tech productive harmony importing low-tech goods from the extra-Atlantean world.
That's why I suggest that a narrower "bandwidth" for interest rates (5-10%) would reduce the "oscillation", (or correlation) that the graphs seem to show.
...even from the graph, you can see a zone of stability within those limits (at about 6%).
Around 2001, rates fall below that range, and prices begin to inflate; rates are then swiftly returned to 6% and prices stabilise; then rates are dropped out of that range until the present and as you observe - off they go into the stratosphere!
Banks need to make some money off it ...that's their revenue stream; the BoE ought to wop up rates to 10% ASAP, and burn off the rot of loans that should never have been issued (but obviously the regime don't dare), and let them drift down to 6% over 5 years, and hold them there for another 5 years (I'm not a Stalinist! but a bit of reliable forward planning would probably help). There needs to be a return to the old "3-times-your-salary" rule as a legal limit in order to rein in the lunacy (and inflation); as well as a moratorium on immigration (including EU); and a part-nationalisation of property to mop up all those defaulted mortgages that would accrue under such a policy... sadly, there's little chance of any leader with vision and guts to squarebash the country into shape ...so I predict a rough ride and protracted denial, with bouts of mild rioting and electoral "surprises" as heightened public expectation goes dramatically unmet... anyone still got their "Things Can Only Get Better" CDs?!
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