Interest rates

Having looked at the property records for several dozen houses now, I've gotten a general sense (not data) for average financing in Chapel Hill. The most common feature is 10% down. This is usually accomplished by a 80% first mortgage and a 10% second mortgage. Fairly often, I'll see an additional HELOC on top.

When you require 10% down, there are more people who can bid price X than if you require 20% down. Fewer people have twice as much in savings. This means that requiring 10% down inflated demand and prices rose. Now that banks are back to requiring a 20% down payment, prices will have to fall.

That's said and done. I think the price drop associated with the 10->20% DP increase will have been factored into the market by the end of next summer.

The other shoe to drop will be the increase in interest rates. If you buy at a 4.5% interest rate, and two years down the road, someone else is only able to get a 6.5% interest rate, then you loose some serious cash. (I'll get to that math below.) The fed succeeded this summer in keeping interest rates at historic lows. They gingerly placed delicious cheese wedges on the door steps of houses all across america to lure unsuspecting consumers into the debt trap that the previous owners had set for them. Todays borrowers were betrayed by their government. I feel sorry for them, and five years down the road, when they start going into default in record numbers or just start mailing their keys to the banks, I'll understand their protest.

On the other hand, they're idiots for buying now, and I have trouble feeling bad for idiots for very long.

Here's the deal with interest rates. There are X houses and X buyers. The houses are of varying qualities and the buyers have varying levels of income. If you were to sort all the buyers and houses by income and quality, then you would be able to assign each buyer to a house. This is more or less what the market does. Buyers with higher incomes are able to bid more agressively in order to obtain houses of higher quality. Everyone bids as much as they're willing and able.

A buyer's income dictates the monthly payment they're willing to shoulder. Monthly payment and interest rate together dictate the principle that the buyer is willing to bid. Assuming incomes don't change (they haven't for the past decade!) and that everyone gets the same interest rate, the principle is irrelevant. The real bid is the monthly payment burden. "My income is Y so I'll shoulder Z per month."

When a person with income Y willing to make a monthly payment Z takes out a loan at a 4.5% interest rate, the principle of the loan they're taking out is greater than if they are offered a 6.5% interest rate, but still constrained to a monthly payment Z.

Some real numbers. Plug them into this calculator if you'd like:
$500K house
4.5% interest rate, 30 yr
20% down.
400K loan

= $2,026 Month.

They have 100K "invested" in the house.

Now

Someone is going to purchase their house two years from now at a 6.5% interest rate. They also can afford a $2,026 monthly payment. What can they bid?

$2,026 Month
6.5%
$320,000
+20% downpayment
= $400K bid.

In two years, the $100K down payment evaporates. 20% loss on the property because the interest rates rose 2 points. This is why everyone is wondering worriedly about just how long the Fed can keep interest rates this low.

This is the worst possible time you could buy. Don't let a realtor tell you otherwise.