What The Recent Surge In Rates Means For Your Home Purchasing Power

Contrary to what one may have read in the financial tabloids, a houseing market does not recover thanks to Fed-subsidzed REO-to-Rent loans used by the biggest private equity firms to buy up distressed property on the margin, by foreign oligrachs buying Manhattan triplexes sight unseen just to park 'tax-evaded' cash courtesy of the NAR's anti money-launderingexemption, and by foreclosure stuffing from the big banks desperate to subsidze the market higher before the sell into it. The recovery comes from the average consumer, who has disposable income and savings (in a hypothetical scenario of course) and who can buy houses based on a given monthly budget - a budget which must provide a better deal to own than to rent.
The problem with such a budget is that first and foremost its purchasing power is dependent on interest rates, and in an economy in which leverage is everything, rising rates mean a collapse in purchasing powerHere is a glimpse of what has happened to the mortgage rates in the past month alone: from Bloomberg's Jody Shenn:
Wells Fargo & Co., the largest U.S. mortgage lender, is offering 30-year fixed-rate loans at 4.5 percent, according to its website, up from 4.13 percent on June 18 and 3.88 percent on May 22, when comments by Bernanke to lawmakers and the release of the minutes of the last Fed meeting caused bonds to plummet. Freddie Mac’s survey, which is lagging behind the bond slump because it reflects originator responses through yesterday, showed average rates falling to 3.93 percent this week.
So in one month, the average 30 year fixed rate mortgage has jumped by over 60 basis points. What does this mean for net purchasing power? Well, as the chart below shows, assuming a $2000/month budget to be spent on amortizing a mortgage (or otherwise spent for rent), it means that suddenly instead of being able to afford a $425K house, the average consumer can buy a $395K house.
This means that, all else equal, housing just sustained a 7% drop in the average equlibrium price based on what buyers can afford.
But assuming the current selloff in rates continues, things are going to get much worse: we may be seeing 5%, 5.5% even 6% and higher mortgages in the immediate future.
It also means that a buyer who could previously afford a $506K house with a $2,000 monthly budget at an interest rate of 2.5% will be able to afford only $316K if and when the average 30 Year fixed hits 6.5%: a 40% drop in affordability based on just a 4% increase in interest rates!
And this is bullish for the economy?
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