Recalling the days of 18% mortgage rates

Forty years ago this month, U.S. mortgage rates hit 18.5%. That stunning Oct. 16, 1981, reading of the average, 30-year fixedrate mortgage came during a period of soaring inflation. Bold moves by the Federal Reserve iced consumer prices that were surging 14%.

The Fed’s toughlove tactic worked and inflation cooled with homeowners benefiting greatly. How much so?

California home prices have appreciated 546% since 1981, rising to $759,200 from $117,500. My trusty spreadsheet analyzed 40 years of California home values using a Federal Housing Finance Agency price index, average mortgage rates and inflation trends.

The ensuing price increases were the product of economic growth, a growing population and various homebuying incentives. In other words, four decades of falling rates gave house hunters a 252% boost in lending power.

Yes, roughly half of the post1981 price hikes can be tied to cheap money.

For folks who had what lenders want — a steady paycheck, solid bill-payment history and a decent down payment — this long-running rate decline was typically a financial home run. But looking forward, some tough questions emerge. Will today’s inflation — at a 13-year high in September — force mortgage rates significantly higher? Will housing remain a wealth generator when buyers can no longer expect ever-shrinking interest rates?

Let’s ponder how the market got to this juncture, using quarterly homebuying data …

1976-81: The prelude

A hot U.S. economy in the late 1970s collided with an oil embargo, and inflation took off.

The Fed then squeezed the supply of money, and all interest rates jumped on whatever little lending was done. The ensuing economic turmoil helped Ronald Reagan boot Jimmy Carter from the White House.

California homes saw 112% appreciation in these five years with annualized swings ranging from 27% gains to 8% declines. But accounting for overheated inflation — which averaged 9.6% in this period — “real” price gains were just 32%.

Note that a buyer’s theoretical house payment jumped almost fourfold. Why? Rates ballooned from an average 8.9% in 1976’s fourth quarter to 17.7% at 1981’s end.

1981-91: Bust then boom

Those high rates led to a harsh recession that cured the national cost-of-living headaches.

Inflation averaged just 4.3% over these 10 years. The resulting falling interest rates juiced the economy and California’s housing market.

Creative lending — notably adjustable-rate mortgages — helped get housing through this wild era. Not to mention the government’s decision to let key mortgage makers of those days — savings and loans — stay in business even though the mortgagerate spike essentially bankrupted most of them.

California prices rose 95%, in a yo-yo period with 23% annualized gains and 10% declines. Buyer’s house payments rose only 3% in 10 years because rates fell from 17.7% to 8.7%.

1991-2001: Malaise to madness

The fall of the Soviet Union and S&Ls were a double gut punch to California’s economy and housing markets.

Good-paying aerospace jobs were lost as defense spending tumbled. S&Ls went out of business, costing U.S. taxpayers at least $125 billion and all but eliminated California housing’s friendliest lenders.

A meek economy and weak real estate marked much of the first half of this decade — when the seeds of the next boom-tobust cycle began.

In this span, home prices rose just 38% — ranging from 14% gains to 6% declines. Mortgage payments rose only 15% as rates fell from 8.7% to 6.9%.

2001-11: Easy money

California housing shrugged off technology’s dot-com bust at the turn of the century only to create its own bubble fueled by easy-to-get loans.

The fallout of that mortgage madness tanked not only the housing but the global economy. It was a home-price roller coaster, with California’s market gyrating from 29% annual gains to 23% declines.

When the carnage was over, California prices were still up 22% over those insane 10 years. You can thank low interest rates used to revive housing after the bubble burst.

A buyer’s payments actually fell 10% in this time frame as rates went from 6.9% to 4%.

2011-21: Rebound

At the time, buyers saw historically low mortgages rates in addition to suddenly affordable home prices due to the broken bubble’s dramatic depreciation. Both of these factors helped pull housing out of its self-inflicted debacle.

The post-Great Recession economic rebound gave housing even more support. Until the coronavirus chilled the world economy. Yet surprisingly, homeownership became the new “must-have” item in the pandemic era.

Mortgage rates played a role, too, pushed to a new, record-breaking low of 2.65% as 2021 started.

Since the bubble-bursting wrath ended a decade ago, California home prices jumped 97%. For the state, it was a relatively tame period with price changes swinging from up 16% a year to down 6%.

A buyer’s payment rose only 61%, thanks to a Federal Reserve focused on keeping mortgages cheap and flowing. Support included adding $1.1 trillion in home loans to its holdings since the virus hit.

What’s next?

It’s hard to ignore the cost of living, especially when this year’s 5%-plus inflation pace is higher than mortgage rates. This kind of economic anomaly hasn’t happened since 1980.

What does this mismatch mean for borrowers?

Yes, significant and extended economic growth and fatter paychecks could help ease the California homebuyer’s affordability crunch. A demographic bump of young adults of prime homebuying age also could boost demand. Faster homebuilding would create more supply, too.

Let me focus on known quantities. Like the 14% annual inflation rate of October 1981 cascading into actual deflation surrounding the Great Recession. And mortgage rates, peak to bottom, dropping almost a full 16 percentage points.

Forty years ago, the hypothetical California buyer mortgaged a typical home for $1,397 monthly, assuming a 20% down payment at mortgage rates’ peak.

In 2021, a similar house hunter writes a $2,560 check to the bank each month for the midpriced home using this year’s almost unprecedented low rates. Yes, payments are 83% higher for housing that’s six-times-plus more expensive.

Is anybody expecting a repeat?