Why high mortgage rate is dangerous

If the mortgage rate is high, more people would prefer renting apartments instead of buying a house. That drives rent prices up. The problem is that due to the high inflation, the price of a house also rises.

The price for housing also rises when the mortgage rate is low. Then it is much easier to take 30-year long mortgage and get your own housing instead of paying expensive rent and getting nothing at the end of the rent term. Then more people will buy a house with a mortgage. With higher demand comes higher price. So the price for housing rises.

Freddie Mac, 30-Year Fixed Rate Mortgage Average in the United States [MORTGAGE30US], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/MORTGAGE30US, September 13, 2022.

In some countries, government incentivises taking a mortgage. Military servants usually get lower mortgage rates. In UK if a person above 18 buys his first house for less than 500k$, he pays only half of a house price. In Netherlands, government insures mortgages, meaning, if a person is insolvent to pay for a mortgage, government will buy a house from a bank, and return money from mortgage payments to a person. The government will also give a discounted rent for a person (I will check this information, I can be mistaken). Therefore the prices for a condo in Amsterdam tripled (if i don’t mistaken). All of these incentives drive prices for housing up.

Real estate market has a huge problem – it is hard for prices to fall. Not only because of scarcity of land, higher price for materials and labor costs. There are no market mechanisms to make prices fall. In the stock market, it is possible to short stocks – sell the stock that you don’t own, and buy it back when price falls, making the profit in the difference. Short selling works with stocks, because the stocks of one company are identical, their value is always the same.

It is not possible to find 2 exactly the same houses, even Soviet flats have different views, neighbors, and house condition. Therefore, short is not really possible.

To lower the housing price, either the place should loose the attractiveness or the new technologies should make housing cheaper. That what happens in the US market. New housing for the mid-class household became simplier and smaller than before. Remember the housing in Manhattan and Brooklyn of 20th century – the red brick houses with fire stairways on the façade. Compare their quality and design with new housing: the cheap coloured ventilated panels with studio apartments.

How 9/11 affected housing prices

The example of attractiveness loss was on 9/11. Based on the Federal Reserve Bank of New York, most of the employees who worked nearby moved to other parts of New York City or New Jersey. The rent prices for an office in Manhattan dropped from 52.5$ to 50.75$ per square foot. By November 2001, 57 million square feet near Trade Center were traded on market just for 41.81$ (Pearson, Macroeconomics, page 54). but that happened with offices. What about the households?

More people started to buy one-family houses near New York. The prices went up 10-15% comparing with previous year. Even thought, the average price of one-family house in the US has fallen.

Mortgage crisis

After looking at the graph, we see that there was only one fall of housing in the Mortgage crisis of 2008-2009. The crisis basically happened, because banks gave too much mortgages to people, who had a huge risk to become insolvent.

Thousands of people couldn’t pay off the debts. Their houses were put for a sale. The supply of houses was so high, that the prices went down. Construction companies stopped building houses, just because there were not too much people who could afford houses and not so much banks would give mortgages. For construction companies it is very bad – they should sell nearly 70% of housing as fast as possible to pay off the debts. Therefore, a lot of companies became bankrupt and ceased the construction of objects.

Such situation lasts till the supply is covered by demand. Meaning that prices fall to a fair price. When it is happened, the construction continues.

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2022   english   Finance   Real Estate
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