Mortgage rates rose in October to their highest level in seven and a half years and are expected to rise further in the coming year. A rise in rates may dissuade homeowners from moving. And for households that are relocating, the rise in monthly mortgage payment relative to rent may discourage home buying.
Comparing the mortgage payment with rent not only affects the buy versus rent decision of households, it can also indicate whether a local area is overvalued. Places where the mortgage payment is much higher than its historical relationship with rent could see not only a falloff in home buyer activity, but also a dip in sales prices.
The house-price bubble during 2004 to 2006 is an example of when the mortgage payment increased well above single-family rent and then fell sharply after 2007 as home prices declined. Using CoreLogic’s sales-price data and Single-Family Rent Index, we traced the boom-and-bust pattern for several metros. Los Angeles and Washington, DC are metros that had a doubling in the mortgage payment-to-rent ratio between 2001 and 2006, with a subsequent crash. In contrast, this ratio remained more stable in the Houston area. (Figure 1)
By comparing the payment-to-rent ratio in 2018 with its value in 2001, we can determine whether the buy-versus-rent decision has become more or less favorable for home buyers. We can also see which metros may be at greater risk of a home-price correction. We found several metros that have mortgage payment-to-rent ratios that were more than 10 percent higher than in 2001. Other metros had payment-to-rent ratios that were close to or less than what they were in 2001. Metro areas with high payment-to-rent ratios are more likely to see slowing sales and less price growth. (Figure 2)
If mortgage rates move higher in coming months, as expected, then metros that have affordably priced homes for sale relative to rental will likely continue to have steady or increasing sales, whereas markets where mortgage payments are high relative to rents are at greater risk of experiencing cooler home sales and lower sales prices.
The monthly mortgage payment calculation uses metro median sales price by month from CoreLogic’s Real Estate Analytics Suite, assumes 80 percent loan-to-value, and financed by a 30-year fixed-rate mortgage with interest rate from the Freddie Mac Primary Mortgage Market Survey. The payment is taken as a ratio to the CoreLogic Single-Family Rent Index; the monthly time series is averaged to create quarterly values and recalibrated to equal one for the first quarter of 2001. The first quarter of 2001 was used as the comparator period because it was the peak of the business cycle (as determined by the National Bureau of Economic Research) and the CoreLogic Market Conditions Indicator found that none of the metro areas in Exhibits 1 and 2 were overvalued that quarter.
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