All of the real, inflation-adjusted U.S. home price appreciation from 1990 to 2021 was due to falling interest rates, at least according to this simple analysis.
U.S. mortgage rates may never go lower than they were last year so the multi-decade Great Appreciation of house prices is now over.
Decades of Falling Mortgage Rates
In January 2021, mortgage rates likely bottomed out after trending lower for decades.
Also in January 2021, the U.S. median single-family house price was $343,000, according to Redfin. Using the Case-Shiller Home Price Index adjusted for inflation, we estimate that on average those $343,000 houses would have been worth $178,000 in January 1990 (in January 2021 dollars).
The result is that nationally, on average, houses that in January 1990 were worth $178,000 (in January 2021 dollars) would appreciate and become worth $343,000 in January 2021. The house appreciated $165,000 (in January 2021 dollars) or 93% from 1990 to 2021.
How much of that 93% real appreciation was due to falling interest rates? It appears all of it was.
Falling Rates and Appreciation
The average 30-year fixed-rate mortgage rate in January 2021 was 2.74% but in January 1990 it was 9.90%, according to Freddie Mac.
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With a 2.74% mortgage interest rate, the monthly payment on a $343,000 mortgage in January 2021 would have been $1,400 per month.
However, with a 9.90% mortgage interest rate–the rate back in January 1990–you could only borrow $161,000 with that same $1,400 monthly payment.
When mortgage rates went from 9.90% to 2.74% the amount you could borrow with a $1,400 monthly payment increased from $161,000 to $343,000, or by $182,000. It looks like lowering mortgage rates from 9.90% to 2.74% added $182,000 to the purchasing power of buyers and that would explain all of the estimated $165,000 increase in the real value of these theoretical, median priced, constant quality, houses from January 1990 to January 2021.
We might say that more than 100% of the real, inflation-adjusted appreciation in house prices from January 1990 to January 2021 was due to lower interest rates.
Now that mortgage interest rates appear to have bottomed out, what happens to real house price appreciation in the future?
The Great Appreciation is Over
The largest driver of mortgage rates is the Federal Reserve’s Federal Funds rate. In the future, the Fed will raise and lower interest rates as usual but the overall trend won’t be lower and lower rates like it was for the last 30-plus years until January 2021.
Now, theoretically, the Fed could change its current policies and make the Federal Funds rate go below 0%. That would also lower mortgage rates below January 2021 levels but a negative Federal Funds rate seems unlikely.
Since the Great Recession, the Fed has also used quantitative easing to lower mortgage interest rates. Although the Fed is–very slowly–downsizing that program now, the program is so large it’s hard to imagine the Fed will ever make the program larger than it is now.
The net effect is that unless the Fed gets a new tool in its toolkit, the Fed won’t be able to lower mortgage rates more than they did in the recent past, and in the future, mortgage rates aren’t likely to go lower than they were in January 2021.
A Future Without Much Real Appreciation
What happens in the future if mortgage interest rates have bottomed out and we don’t have generally falling mortgage interest rates pushing up real house prices and home-owner family wealth over the next 30 years?
House prices will still go up with inflation but, nationally, real, inflation-adjusted prices wouldn’t go up much, or at all, for the foreseeable future in this scenario.
Significantly less real house price appreciation would mean significantly less real family wealth creation via home ownership and, possibly, slower family wealth creation, overall. A much larger percentage of family wealth would come from simply paying off their mortgages and far less, or none, would come from real home price appreciation.
Possible Impacts
- The home ownership rate could very well increase because with less house price appreciation the demand from investors would fall more than the demand from live-in owners.
- The foreclosure rates would increase, all other things being equal, since there would be less house price appreciation to help out recent home owners hit with unexpected financial reversals.
- But, on the other hand, with slower price appreciation, some first-home buyers would feel less pressure to buy before they’re financially ready, and that would help reduce their future foreclosure rate.
- We’d likely see greater downside risk to house prices. In the past, the Fed has sometimes lowered interest rates during recessions when house prices were falling but that can’t happen when rates have already bottomed out and the Fed can’t lower them anymore.
- We’d likely see fewer and smaller house price booms caused by the Fed decreasing interest rates when the real estate market is already hot.
- With houses appreciating less, some owners will compensate by saving and investing more elsewhere.
- Wealth inequality between home owners and renters would be greatly reduced over time.
- Having decades of lower house price appreciation than the Baby Boomers had means Social Security and savings would become relatively more important for Millennials and Gen-Z in retirement.
The Future is Easy to See
Government policies should reflect our new reality where most real, inflation-adjusted family housing wealth comes from paying off mortgages and owning their homes free-and-clear.
Government policies in the past have often promoted high foreclosure mortgages with the idea that rapid house price appreciation would save home owners, if they got into trouble financially. But with expected real appreciation being much slower or nonexistent in the future, government policies should shift to promoting maximum free-and-clear home ownership instead of promoting maximum mortgage-ownership and calling it the American Dream.
Government-backed mortgages, for example, should be redesigned to maximize family wealth creation and to have low foreclosures even without real house price appreciation. If we don’t prepare for this new, easy to see coming, reality, we could see unnecessarily high foreclosures and unnecessarily low family wealth creation, and later, unnecessary challenges for Millennials and Gen-Z in retirement.