Huge Rate Hike Shocks Housing Market
Some buyers no longer qualify; could ease home prices
This past week, the Federal Reserve hiked interest rates by 0.75%, an uncommonly large jump that sparked another significant rise in borrowing costs on everything from home loans to business working capital lines to cars and credit cards. It was just six weeks ago when Federal Reserve Chair Jerome Powell said, “A 75 basis point increase is not something that the committee is actively considering,” but high inflation coupled with a historically tight labor market led the Fed to act.
According to the St. Louis Federal Reserve/FRED, the average 30-year fixed rate mortgage rate shot up to 5.78% this week after being at 5.09% at the beginning of June and a mere 3.11% at the start of the year, although based on what I am seeing rates are even higher than that for residential loans and Mortgage News Daily reports the average 30-year fixed rate is all the way up to 6.28%, so it’s possible the FRED data is behind by a few days. Nonetheless, the FRED chart below shows the average 30-year fixed mortgage rate over the past five years including the steep run-up in rates since January:
What is Happening?
On June 10th, the Bureau of Labor Statistics released its monthly inflation report showing prices were up by 8.6% on a year-over-year basis; economists had been predicting 8.2%, which still would have been high but it would have represented more of a slight easing over previous months. The 8.6% figure came in hot and markets reacted accordingly with the stock market posting its worst week since 2020, bond markets getting clobbered, and interest rates rising even on the heels of steady and significant increases over the past few months. The Fed has a dual mandate to promote full employment and keep inflation around 2.00%, so with employment being historically strong but inflation rising rapidly, the Fed is taking the opportunity to try to clobber rising prices before they spiral even more out of control.
Has this Happened Before?
The most famous period of rising interest rates in recent U.S. history was in the early 1980s as Federal Reserve Chair Paul Volcker during the administration of President Ronald Reagan rapidly increased rates to tame inflation, knowingly taking the U.S. economy into a recession in order to do so. The average interest rate on a 30-year fixed mortgage crested above 18% in 1981, although rates were above 10% for most of the next ten years.
Another example of the Fed hiking rates came in 1994, during which time according to Sergei Klebnikov of Forbes the Fed was actually able to engineer the so-called “soft landing” they seek today by cooling inflation without completely obliterating the economy:
The last time the Federal Reserve raised rates by 75 basis points was in November 1994 when the central bank was able to orchestrate a soft landing by tightening monetary policy ahead of rising inflation. That increase was part of a series of rate hikes by then Fed Chair, Alan Greenspan, who raised rates seven times over the course of 13 months, from 3% to 6%, between early 1994 and early 1995 in an effort to keep the economy from overheating.
What Comes Next
Those most clearly frustrated by rising interest rates are prospective homebuyers, who have already been challenged by rapidly rising prices and precious little inventory. The inventory challenge may remain in part because many existing homeowners will be reluctant to sell since they would need to buy (or rent, for that matter) in such a challenging environment. Unless you absolutely need to move for work or family or some other specific concern, most existing homeowners probably have an interest rate between 2.75%-4.00%; why give that up and buy into an inflated market at a 6.00% rate?
Anecdotally speaking, I have seen several examples over the past couple of weeks of prospective homebuyers no longer qualifying for a home loan at least at the same dollar amount as they did a month ago. Since one’s debt-to-income ratio is one of the most important metrics in the residential underwriting process (and commercial too, by the way), if the monthly payments on a proposed loan increase as interest rates rise, the debt-to-income ratio is detrimentally hurt, sometimes to the point where a person no longer qualifies for the loan.
Those that do qualify often now qualify for less. Consider this: according to Holden Lewis, a housing expert at personal-finance site NerdWallet via ABC News:
When the rate for a 30-year fixed mortgage stood at 3.25%, buyers who could afford a $1,500 per month spend on the home principal plus interest, could borrow enough to afford a $345,000 home…At the current rate, roughly 6.00%, the same homebuyers can borrow about $250,000, reducing borrowing capacity by about $95,000, he added.
On a broader level, I believe that rising interest rates will actually have their desired effect of cooling inflation. As the cost of borrowing increases, both individual consumers and businesses will not be able to leverage growth through debt as easily, which will have a dampening effect that will ripple through the economy. Plus high prices themselves will have a negative dampening effect on the economy as people are just not going to have as much money to spend with so much of their disposable income going into the gas tank and being spent at the grocery store. The billion dollar question, of course, is how bad will this “dampening” be.
A Silver Lining?
For those who do still qualify for home loans, rising interest rates may bring the advantage of cooling off prices a bit. I have written several times over the past year about how I don’t believe we are in a housing bubble, but that I do see prices eventually leveling off. I think that will come sooner rather than later. With fewer buyers in the market because some no longer qualify and with those who do still qualify not necessarily qualifying for as much, the market will soften. The first evidence of this will not be a drop in prices, but a deceleration of prices, which means that the rate of increase will ease off to an eventually plateau with drops in certain overheated markets.
Either next week or the following I plan to write a mid-year housing market overview and I will revisit some of my thoughts from my 2022 housing market preview in January, so check back in a week or two. If you have questions about the housing market or things you’d like be to touch on, leave them in the comments below or send me an email at bsprague1@gmail.com or ben.sprague@thefirst.com. Thanks for being here and thanks for subscribing.
Ben Sprague lives and works in Bangor, Maine as a Senior V.P./Commercial Lending Officer for Damariscotta-based First National Bank. He previously worked as an investment advisor and graduated from Harvard University in 2006. Ben can be reached at ben.sprague@thefirst.com or bsprague1@gmail.com. Follow Ben on Twitter, Facebook, or Instagram. Opinions and analysis do not represent First National Bank.
Happy Father’s Day
Happy Father’s Day to all the dads, grandads, and father figures out there. I am fortunate to have a great day and to be a dad to three wonderful kids. The frame below is own my desk at home. I am in both pictures!
Have a great week, everybody.
As you know, I have been in business for over 40 years. And I was selling real estate during the 18% years. One of the things i have noticed is the more the News talks about its not a good time to buy, we are in a bubble, etc, the more people listened. Many people shut down their buying plans to wait for a better market condition. I believe that will happen again this time and the market will cool from 2 sources, the higher interest rates and the News.