It's common sense that low mortgage rates are important to the housing market. They make purchasing a home more affordable and make refinancing more attractive for current homeowners.
But low mortgage rates have other important benefits, too. Provided low borrowing costs don't go to the extremes we saw in the boom, cheap credit can be part of a virtuous cycle. Here's a look at how homeowners, the housing market, and the economy benefit from record low mortgage rates:
Increased demand. Low mortgage rates help create demand for housing because would-be buyers want to jump on cheap financing before rates go up. This March, new home sales were more than 18 percent above levels reported a year earlier according to the Commerce Department. Existing-homes sales saw a jump too, rising more than 10 percent year-over-year in March, according to the National Association of Realtors.
Rising prices. Heightened housing demand has stripped the available supply down to very lean levels, which in turn has fueled rapid home price increase in some markets. Since March 2012, the median existing-home value was up almost 12 percent, while prices for new homes rose about 3 percent. Measures from Case-Shiller and others home-price trackers put yearly gains at around 10 percent as well. Rising home prices are a key component to fixing the housing market.
Rebuilding equity. Crashing home prices during the financial crisis plunged millions of homeowners underwater on their mortgages. While regular monthly payments will slowly re-balance the scales, recovering lost equity could take years.
Rising home prices help fill in these equity holes much more quickly. Negative equity – owing more on your mortgage than your home is worth – has dropped 41 percent since last March according to a recent LPS Analytics report.
Why is all this important?
First, it means that someone who wants to sell their home and move (following job prospects, for example) can do so without having to write a check to the bank at closing, and can eliminate the need for a messy and protracted short-sale process.
There are benefits for homeowners who want to stay put, too. Rising home prices, like stock prices, contribute to the "wealth effect," in which homeowners feel more confident about spending money. This in turn helps prop up the economy and create jobs.
Also, rebuilding lost equity can also open up a source of low-cost credit, such as a home equity line of credit. Lenders tightened home equity standards a couple of years ago, and it has been hard to leverage all the equity in a home because about 10 to 20 percent must remain untouched. Rising home prices can create that borrowable equity, which is valuable for everything from debt consolidation to home improvement.
There are limits, however. If home prices rise too far or too fast, affordability can fall and incomes would need to rise or mortgage rates would have to fall even further to compensate. Neither of those seems likely. The last time such a situation occurred, "exotic" mortgages designed to enhance affordability spread through the market like wildfire and were the proximate cause of the mortgage crisis.
For now, affordability remains strong despite home prices rising by double digits on a year-over-year basis. Since there is little likelihood home values will return to at or above-market peaks anytime soon, low mortgage rates will continue to bring benefits to homeowners.
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Keith Gumbinger of HSH.com is a 25-year expert observer of the mortgage and consumer debt markets. He has been cited in media outlets from CNN to NPR to the Wall Street Journal and is the primary researcher and writer of HSH.com's consumer guides and Market Trends newsletter.