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Sometime soon may be a reasonable time to buy a house [ClearOnMoney]
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Sometime soon may be a reasonable time to buy a house

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Commentary

Sometime soon may be a reasonable time to buy a house

16 Dec 2009 by Jim Fickett.

On the one hand one should wait to buy a house, as prices are quite likely to fall further. On the other hand, one should buy now, as interest rates are near a historic low point, and are likely to start rising soon. How these forces balance out depends on one's individual situation. On average, however, for those who would stay in a house more than a few years, the interest savings might well cover or exceed the further drop in price.

House prices are very likely to fall further, mainly because inventories are still historically high and the record foreclosure wave is far from its end, which will keep inventories from normalizing. The bounce in prices this year was probably a blip, caused by the first time home buyer's credit and a lull between the subprime crisis and the prime crisis.

No one knows for certain how it will all play out, of course, but to get an idea of where prices might bottom, we can use projections from two sources that have done a good job of predicting the course of events so far: Moody's Economy.com and Deutsche Bank.

Moody's Economy.com (according to an 11 Dec 2009 USA Today article) projects that the national median existing home price will bottom out at about $146,000. As of Oct 2009, the median price was, according to a 23 Nov 2009 National Association of Realtors press release, $173,100. That would be a fall of 16%.

Deutsche Bank last made public a prediction in Jun 2009. In a 16 Jun 2009 article in Time, it was stated that from June, Deutsche foresaw a decline of 14% to the bottom.

These two predictions are broadly consistent – 14% decline from June, when prices were a little lower, or 16% from November.

Against this further drop in price, one can put likely savings on interest. 30-year fixed rates are at historic lows. The following graph is from a 10 Dec 2009 US Treasury press release:

Rates are artificially low right now. The Federal Reserve's quantitative easing program involved buying long-dated Treasuries, so-called agency debt (issued by Fannie Mae and Freddie Mac), and mortgage-backed securities. By competing with other buyers the Fed intentionally drove prices up and, therefore, rates lower. However the Treasury-buying program has already ended, and in today's Open Market Committee policy announcement the Fed confirmed that the mortgage-related purchases will end, as scheduled, in the first quarter of 2010.

To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve is in the process of purchasing $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. In order to promote a smooth transition in markets, the Committee is gradually slowing the pace of these purchases, and it anticipates that these transactions will be executed by the end of the first quarter of 2010.

Today's Financial Times, in an article entitled Moody’s warns on sovereign debt, reported,

Bankers say emergency support measures such as quantitative easing have depressed yields on benchmark government bonds by about 40 to 50 basis points.

This, and an analysis at Calculated Risk, suggest that rates are likely to rise about half a percentage point in the next few months. After that it would be surprising if rates did not rise further, because (1) they are extraordinarily low right now, (2) the Fed will eventually raise the short-term rate, and (3) the US is issuing more debt than ever before in history, and excess supply will eventually reduce prices and increase yields.

Suppose, then, that 30-year fixed rates are two percentage points higher in 2 years, and stay at least that high for several years after that. If one were to lock in the low current rate, and hold the house for 10 years, one would save about 18% of the mortgage principal. There are additional tax savings, as well.

There are, of course, many unknowns that could change the equation. Also, local housing markets are very different, while this argument has only been made about national averages.

Still, the main point is robust – for purchases in the next few months, long term savings on interest are very likely, and this takes the pressure off on waiting for the market to bottom.