Will rising mortgage rates undermine home prices? | Pound Ridge NY Real Estate

Thanks to freakishly low interest rates, many homeowners with mortgages are able to make their monthly house payments using a much smaller percentage of their income than has been the historical norm, an analysis by Zillow shows.

But home prices are actually more expensive relative to median annual incomes than they were during the pre-boom years, which raises a troubling question: What happens when the economy improves and interest rates go up?

Because housing affordability is more highly dependent on interest rates than it has been in the past, when rates go up, home values will either have to remain stagnant while incomes catch up, or home values may even have to fall in some markets, said Stan Humphries, Zillow’s chief economist.

Some homebuyers could find themselves newly underwater if rising mortgage interest rates depress home values in their markets.

“Those buyers purchasing with little money down and high initial mortgage balances will be more at risk for slipping underwater if home prices fall marginally,” Humphries said. “Many homebuyers financing their purchase with a mortgage backed by the Federal Housing Administration can put down as little as 3.5 percent of the home price in down payment, and these buyers could be more susceptible to falling into negative equity even with modest home value declines.”

U.S. homeowners in the fourth quarter of 2012 devoted 12.6 percent of their median monthly incomes to mortgage payments, according to Zillow. That’s close to 37 percent more than homeowners paid from 1985 to 1999, Zillow says, when mortgages took up 19.9 percent of a typical homeowners’ median monthly income.