The Correlation Between Mortgage Rates and Home Sales

Low mortgage rates are thought to lead to higher sales numbers due to the economic theory of supply and demand. However, this relationship between mortgage rates and home sales numbers is not always as strong as some economists might think. This is made evident in a study by Christopher Mayer and R. Glenn Hubbard of the Columbia Business School whose findings indicate a more diverse set of influences on home sales.

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In light of the above findings, the correlation between mortgage rates and home sales numbers involves understanding additional variables that can influence home sales. Examples of these factors include Federal Reserve Bank 'quantitative easing' policy, the business cycle of the mortgage industry, economic conditions and federal regulations. Despite all the additional variables that influence mortgage rates and home selling, the connection between mortgage rates and home sales is relatively strong when averaged out historically.

• Quantitative easing

Quantitative easing is a policy practiced by the U.S. Federal Reserve Bank when economic conditions warrant an increase in financial liquidity i.e. availability of funds for banks from the Federal Reserve. When the Federal Reserve Bank lowers its Federal Funds Rate, the affect tends to directly correlate with mortgage rates as the availability of money increases. Another program the Federal Reserve Bank implements is Permanent Open Market Operations (POMO). This program eases the financial strain on financial institutions that are connected to the mortgage industry via purchase of mortgage backed securities

• Statistical significance

The correlation between mortgage rates and home sales numbers is only valid when statistically significant. Moreover, quantitative easing only works under normal market conditions, and not necessarily when the economy is struggling in an exceptional recession, is in a secular trend, or during a housing market down cycle. For example, in an October 2006 document by James D. Hamilton, Economist at the University of California, San Diego, it is claimed the drops in the Fed funds rate leads to changes in mortgage rates that create increased home sales, albeit over time. However, two years later, throughout 2008, home sales declined despite historically low mortgage rates.

• Historical economic trends

The relationship between mortgage rates and home sales numbers is also evident in the economic history of the United States. Historically, when demand for mortgages drop, an indirect correlation also exits between mortgage rates and treasury yields as these financial instruments also decline during times of economic contraction. This pattern is evident in graphs of historical mortgage rates and 10 treasury yields plotted over a timeline. Moreover, the trendline reveals more often that not, that mortgage rates lower when 10 year treasury yields also decline indicating another relationship between government debt and mortgage rates. This is evident in this graph of Federal Reserve data presented by Mortgage and Refinancing Info.

• The U.S. housing market

After the severe decline in U.S. housing market valuation(s) in 2007, the prices of homes plummeted and a financial crisis ensued. As a result of the financial crisis, lenders saw a drop in demand for home loans which caused a corresponding drop in mortgage rates. When graphed, a clear pattern between home sales and mortgage rates emerges suggesting a drop in one may also lead to a decline in the other rather than a rise in home sales due to lower costs. In other words, lower mortgage rates may also have a non-inverse relationship with home sales when a housing market is in a strong enough downward cycle.

• Mortgage regulation

Mortgage regulation also impacts the correlation between mortgage rates and home sales numbers. Following the housing market bubble burst between 2007-2008, the financial services industry gained increased government scrutiny regarding lending practices. A result of this was tighter lending rules requiring larger down-payments, higher consumer credibility and consumer protection rules. One such example being the Dodd-Frank Wall Street and Reform and Consumer Protection Act of 2010. A potential financially adverse side affect of all these rules is an inhibition in the rate of lending despite their perceived benefit to the economy and consumers.

Sources:

1. http://bit.ly/bNMs3p (Federal Reserve Bank of Dallas)
2. http://bit.ly/d5NRSR (Hubbard, Columbia Business School)
3. http://bit.ly/bAjrMx (Bloomberg)
4. http://bit.ly/boXnJX (Hamilton UCSD)
5. http://bit.ly/cLrJH (Truth about mortgages)

Areas of the United States Where Real Estate Has Begun Rebounding

Of the areas of the United States that seem to show a sustained rebound in real estate, Minneapolis and Minnesota showed some signs of economic strength by the third fiscal quarter of 2010 that have translated to price and sales strength since 2008. 

The reason why Minneapolis, Minnesota seems like it can weather any additional real estate volatility is because The Standard & Poor's metropolitan real estate index indicated a 10.7 percent year over year gain in real estate prices in June 2010.

Additionally, The Bureau of Labor Statistics reported a year over year drop in unemployment from 8.3 percent to 6.8 percent for the State of Minnesota between 2009-2010. Add to this a report by the Star Tribune of Minneapolis-St. Paul stating home sales have increased 3.8 percent despite a fairly large drop of over 8 percent since last year.

To pinpoint what areas in the United States are experiencing rebounds and locate informed real estate investing opportunities one might fair well to closely examine employment, population, gross metropolitan product and real estate sales statistics by metropolitan region and geographical region. The results of this may demonstrate the potential for growth in a real estate sector of a metropolitan area such as Minneapolis, and perhaps a state, but the results may still be questionable.

Even if real estate figures show a rebound, it may only be macro-economic in nature i.e. a numerical 'trickle-up' that serves only as a general indication of increased wealth, and that says little of the overall distribution of wealth via real estate in a particular area. Reasons why one might be skeptical of strong real estate rebounds in most areas of the U.S. are described below.

• Western pending home sales trends

The National Association of Realtors has indicated the Western region of the United States had the highest regional value of  pending home sales as measured by the July, 2010 Pending Home Sales Index (PHSI). However, all four regions measured by the index were close to their respective four year lows indicating little regional recovery in home sales since 2009.

• Southern annualized regional home sales

Additional data released by the N.A.R. suggests little change for August 2010 as total existing home sales by region having been trending down since May 2010. In November and December of 2009 home sales numbers for the four regions measured peaked at approximately 2.3 million homes and in July of 2010, aggregate home sales in the Southern region had dropped the least at  an annualized 19.8 percent.

• Midwestern states show less damage

The Bureau of Labor Statistics, Brookings Institution, and Federal Reserve Bank of New York all indicate some Midwestern states as having less damaged regional economies in terms of   lower unemployment, fewer mortgage delinquencies and  smaller metropolitan product differentials than other areas in the U.S. These states however, may have been less damaged by the economy because their economies weren't necessarily on fire to start with i.e. stable rather than volatile.

• County sub-prime mortgage delinquencies

According to the Federal Reserve Bank of New York (FRBNY), in the second quarter of 2010, many if not all states experienced a negative mortgage delinquency rate in terms of the mortgage sample measured. These statistics illustrate a real estate rebound in any U.S. regions faces considerable market pressure against increases in home sales and pricing values.

• State unemployment and housing

Areas of the United States where real estate has begun rebounding are the same locations were regional industry and economy has also rebounded. Since housing prices and sales are linked to employment, and local economics, it is a reasonable leading indicator to consider when assessing rebounding real estate markets. This data can then be confirmed against existing home sales data and trends to test the strength of the hypothesis.

• Short-term vs Long-term data

Additional factors to look at in determining local economic rebounds are both  short-term and long-term real estate statistics. Short-lived rebounds can be brief and less convincing than month-over month patterns and external regional economic conditions can also affect how well and if a local housing market will rebound. This difference in short-term vs long-term real estate patterns can be seen in national real estate trends that can influence smaller real estate markets. The National Association of Realtors indicates real estate sales for each of the four regions measured are at their lowest point since July 2009.

Sources: (Date of record September 20, 2010)

1. http://bit.ly/97Stbj (Federal Reserve Bank of New York)
2. http://bit.ly/aFfPTZ (National Association of Realtors)
3.  http://bit.ly/dwrAU2 (Standard & Poors)
4. http://bit.ly/13xWA (Bureau of Labor Statistics)
5. http://bit.ly/176dwR (Brookings Institution)