Jamie Dimon… He is the chairman and CEO of JP Morgan Chase, the largest of the big 4 american banks. He is one of the most well known voices in finance and due to his position at the top of one of the world’s largest banks, he has insights into the financial markets and the economy unmatched by virtually anybody. That is why it raised a huge red flag for me when I heard what he had to say about what's currently happening in the United States housing market. Given that the housing market is a multi trillion dollar industry and, as demonstrated by the great financial crisis, can have a devastating impact on the global economy, people should be paying special attention to what's going on with housing prices. On the back of historically low interest rates and limited supply, Prices for houses in America have increased dramatically over the past 12 months with the median home price hitting an all time high of $350,000. This drastic price movement is starting to worry Jamie Dimon. In this video, we are going to go over what is causing the rise of house prices and how this rise in prices compares to the build up of the housing bubble prior to the great financial crisis.
Before we go any farther, it is important to understand what exactly is causing home prices to increase at such a fast rate. The rise in prices can be attributed to two main drivers. 1.) Historically low interest rates, and 2.) historically low supply of available houses for sale.
On the first point, due to actions taken by the Federal Reserve, interest rates for mortgages are at some of the lowest rates in the history of the United States. To truly understand the housing market, it is important to understand the drastic impact that interest rates have on home affordability. Generally speaking, the lower the interest rate on a mortgage, the more someone can spend on a house. All else being equal. To demonstrate the impact interest rates have, Let's look at an example of a 30 year mortgage on a $350,000 house with a 20% down payment:
At a 3% interest rate with the given criteria, the monthly mortgage payment would be $1,476. If you increase that interest rate to 5%, that mortgage payment would rise to $1,879, and if you increase the interest rate even further to 7%, that mortgage payment would shoot up to $2,329. Using this example, that means a home buyer would pay nearly $1,000 more every month for 30 years if the rate on their mortgage was 7% as compared to 3%. Once you think about it in these terms, it is much more clear why and how interest rates are able to move home prices so much. The lower interest rates are, the more people can spend on a house without increasing their monthly mortgage payment. This helps to explain that even while home prices have skyrocketed, home affordability hasn’t dramatically decreased. Home affordability, as measured by the Housing Affordability Index, is still substantially above 2005 and 2006 levels in the build up to the housing bubble that caused the Great financial crisis.