Rising interest rates will shake the housing market. Don’t expect it to go down for the count, though.
Mortgage rates have been very low for a very long time. Though they’ve risen significantly over the past year as the pandemic eased its grip and inflation picked up, the average interest rate on a 30-year mortgage has risen from 3.2% to just 4.4% over the past year, according to Freddie Mac . This compares to historically low averages of 4.1% in the decade before the pandemic and 6.7% in the decade before the 2008-09 financial crisis.
Persistently low mortgage rates have changed people’s perception of what a reasonable price is for a home. Consider this: The monthly payment for a $500,000 30-year mortgage at 6.7% interest is $3,226, but it’s $2,176 at 3.25%, which is what CoreLogic estimates this to be as of January was the median interest rate on outstanding mortgages. The difference helps explain why house prices have been able to increase so much without dampening demand. US home prices in December were 31% higher than two years earlier, according to the Federal Housing Finance Agency.
The fall in mortgage rates during the pandemic triggered a refinancing surge that dramatically reduced payments for many homeowners. A significant increase in mortgage rates would create two major problems for the housing market: first, it would make it harder for people hoping to buy their first home at current prices; and second, it would make it more difficult for existing homeowners who are now paying low interest rates to move, because moving would mean giving up a lower interest rate for a higher one. Some will keep their homes much longer than planned, hurting businesses that rely on housing sales. The faster interest rates go up, the more it will hurt.
Economic conditions are already far from ideal for home buying. The Fannie Mae Home Purchase Sentiment Index fell in January to its lowest level since May 2020. Mortgage rates, however, are not the only factor at play in home construction these days. Many members of the large millennial generation have been slow to venture into home ownership, in part due to the setbacks they experienced after the 2008-09 financial crisis.
Despite high and increasing financial hurdles, they finally dare to take the plunge. The pandemic has changed attitudes toward homeownership, while high savings and a strong job market give people the wherewithal to buy. It’s not as if the housing market hasn’t weathered a significant rise in interest rates before. Mortgage rates doubled in the 1970s. And yet, over the decade that ended in 1979, home ownership soared 25%—then the result of a booming push in home ownership.
But with higher rates, the prices people are willing to pay for homes could come under pressure. While it’s rare for prices to fall across the country – the housing bust that sparked the 2008-2009 financial crisis was a rare exception – there have been times when prices haven’t kept pace with inflation, causing homes to fall over the years made time more affordable.
The search for affordability could lead to changes in the types of homes people buy and where they buy them. Some of these shifts are already underway. According to the National Association of Realtors, existing home sales in the West were down 8.3% year over year but were up 3% in the South. where the median home price was almost $200,000 less. Demand for housing in the less expensive suburbs was already picking up before the pandemic and has continued to rise with more flexible working arrangements.
The low number of homes for sale – in February there was only enough inventory on the market for 1.7 months of sales compared to an already low 3.1 months two years earlier – should continue to provide a good backdrop for home builders. But they could benefit by focusing their efforts more on building smaller homes in more affordable neighborhoods — especially if more people who already own their homes are forced to give up the low mortgage rates they’ve locked into. After decades of growth, the average square footage of new single-family homes sold in the U.S. began slowing in 2015, according to the Commerce Department.
Higher interest rates may not make people give up on their home-owning dreams, but they could lower expectations for the type of home they own.
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https://www.wsj.com/articles/rising-interest-rates-will-shift-housings-foundations-11648119600?mod=rss_markets_main Rising interest rates will shift the fundamentals of home construction