80% of Home Price Appreciation Since 1990 Was Due To Falling Mortgage Interest Rates?

What Happens to Home Price Appreciation After Interest Rates Bottom Out?

First, let’s do a quick analysis of some numbers, and then let’s see what they might mean for future house price appreciation and family wealth creation. 

Interest Rates

In January 1990, the average interest rate on a 30-year fixed-rate mortgage in the U.S. was 9.9%. In December 2020, it was 2.7%. 

With an interest rate of 9.9%, the principal and interest (P&I) payment is 0.89 cents per month per dollar borrowed. With an interest rate of 2.7%, the P&I payment is 0.41 cents per month per dollar borrowed. 

The monthly P&I payment per dollar borrowed in December 2020 was less than half the cost in January 1990 due to the lower mortgage interest rate. Or, rather, with the same monthly P&I payment, you could borrow more than twice as much money to buy a house in 2020. 

House Price Appreciation

In January 1990, the Case-Shiller U.S. National Home Price Index was 76.527. In December 2020, it was 232.409. 

That means a house that was worth $100,000 in January 1990 would have been worth just over $300,000 in December 2020, on average. According to this index, the average nominal U.S. house appreciated 200% from January 1990 to December 2020.

1990. The P&I payment on $100,000 at 9.9% interest would be $870 per month.

2020. The P&I payment on $300,000 at 2.7% interest would be $1,227 per month.

Although house prices appreciated 200%, monthly P&I payments only increased 41% due to the lower interest rates. 

Certainly, if mortgage interest rates had remained at 9.9%, house prices wouldn’t have increased nearly as much from 1990 to 2020. But how much less?

How Much Less?

Let’s take the December 2020 P&I mortgage payment of $1,227 per month. If it had a mortgage interest rate of 9.9% like in January 1990, how much money could you borrow? 

• A $1,227 per month P&I mortgage payment at 9.9% interest could buy a $141,000 house.

• A $1,227 per month P&I mortgage payment at 2.7% interest could buy a $300,000 house (in this simplified example without down payments).

That suggests if interest rates hadn’t fallen (but the P&I mortgage payment price stayed the same) that house prices would have only increased around 40% from January 1990 to December 2020. The rest of the 200% increase in house values was due to falling interest rates.

80% of Appreciation Due to Falling Rates

This quick analysis suggests that as much as 80% of the home price appreciation from 1990 to 2020 was due to falling interest rates. Without falling rates, homeownership would have created a lot less wealth.

For example, if you bought a house in 1990 for $100,000 and paid off the mortgage in 2020, you gained $100,000 in wealth by paying off the mortgage and $200,000 in wealth due to the appreciation. 

If, however, mortgage rates had never fallen you would have gained $100,000 in wealth by paying off the mortgage and only around $40,000 in wealth due to appreciation, according to this quick analysis.

Future Appreciation Without Falling Interest Rates

It certainly seems that most of the house price appreciation over the last 30 years has been due to falling interest rates.

So what happens if interest rates have bottomed out and we don’t have falling interest rates pushing up house prices and family wealth over the next 30 years?

Could national house price appreciation the next 30 years be only 20% of what it was the last 30 years? Whatever the number, it seems extremely likely that real U.S. house price appreciation over the next 30 years will be a lot less than the last 30 years.

Scenario: A Lot Less House Price Appreciation

• Significantly less family wealth creation via homeownership.

• Significantly less family wealth creation overall.

• Paying off mortgages becomes a much more important part of family wealth creation.

• Savings and investment rates increase.

• Millennials will have significantly less home equity to draw on during their retirement years than Baby Boomers.

• Social Security becomes relatively more important for Gen-X and Millennials in retirement.

• Wealth inequality between homeowners and others will be greatly reduced over time.

• Foreclosure rates will increase since there will be less house price appreciation to help out homeowners hit with unexpected financial reversals.

• On the other hand, with slower appreciation, first-time buyers will feel less pressure to buy before they’re financially ready which will help reduce their future foreclosure rate.

• High foreclosure FHA mortgages become even higher foreclosure with slower house price appreciation. The negative effect increases exponentially as the percentage of FHA mortgages in a neighborhood increases.

• Greater downside risk to house prices. Typically, the Fed lowers interest rates before house prices can fall but what happens when rates have already bottomed out?

• House prices become more stable on the upside but more unstable on the downside.

• The trend toward building ever-larger new houses slows or, possibly, reverses.

• With less appreciation, demand from landlords falls and homeownership increases. 

How to Prepare for Lower House Price Appreciation

Government policies should shift to promoting free-and-clear homeownership instead of promoting mortgage-ownership at all costs, and assuming homeownership is a magic wand of wealth creation. 

As paying off mortgages becomes a much more important source of family wealth creation, policies should reflect our new reality. 

Step 1. Government-backed mortgages should be redesigned to maximize family wealth creation in a lower house price appreciation environment. If we don’t, we could see family wealth creation tank, and a retirement crisis in 30 years or less.

What am I missing? What have I got wrong? Tell me in the comments below.

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Notes. 1) The Case-Shiller Index is a repeat-sales index which means it looks at price changes for the same house, or constant-quality houses, or equivalent houses. 2) Keep in mind that January 1990 was near the top of the S&L real estate boom.