Mortgage rates are rising rapidly — above 5 percent for the first time in more than a decade — and they’re beginning to dampen the booming housing market.
The 30-year fixed-rate average, the most popular mortgage product, hit the new threshold this week, Freddie Mac reported Thursday. It has not been this high since February 2011.
Low interest rates fueled the US housing market recovery after the Great Recession and helped push home prices to record highs. But after two years of hovering at historic lows, interest rates are on a soar: In January, the 30-year fixed average was 3.22 percent. A year ago it was 3.04 percent.
Although mortgage rates were expected to rise, they have risen faster than many economists predicted. Driven by inflation, interest rates have skyrocketed.
Inflation, which has hit consumers hard on a daily basis, is also causing pain for home buyers. A few months ago, a homebuyer wanted to pay $1,347 a month on a $300,000 loan at 3.5 percent. If the buyer waited until this week, the same loan at 5 percent would increase the monthly payment by $263 to $1,610.
The Federal Reserve’s efforts to tame inflation are fueling interest rate hikes. Although the Fed doesn’t set mortgage rates, it does affect them. The central bank took the first steps to bring down inflation in early March when it raised interest rates for the first time since 2018. In addition to raising interest rates, the Fed will soon begin the process of reducing its balance sheet.
The Federal Reserve holds approximately $2.74 trillion in mortgage-backed securities. It said it would announce its plans to reduce its holdings at its May meeting. The more aggressively the Fed sells these bonds, the faster mortgage rates are likely to rise.
Housing costs are not only a burden for buyers and sellers. It has also proven to be a major complication for the economic recovery and potentially jeopardizes policymakers’ ability to contain the inflation that has seeped through the entire economy.
Inflation is rising at its fastest pace in 40 years, with prices up 8.5 percent in March from a year earlier. Accommodation accounts for a large chunk – about a third – of the basket of goods and services used to calculate inflation, or what is known as the “Consumer Price Index”. This means that unless housing costs reverse significantly soon, headline inflation will be all the more difficult to ease back down to more normal levels.
Accommodation costs are also different from other categories like gas, groceries or plane tickets, which may be more vulnerable to forces like the ongoing pandemic, supply chain disruptions or a war.
For example, gas or energy prices are unlikely to remain as high as they were when Russia invaded Ukraine and had a huge impact on world energy markets. Groceries can also become cheaper as supply chains smooth out over time.
But these forces do not apply equally to housing costs. Landlords who can get higher rents are unlikely to lower prices a year later. Buyers will continue to clamor for the few homes available. And with the housing market supercharged by competitive bidding wars and cash offers, it’s unclear how drastically demand will need to cool before housing costs meaningfully reverse.
Even Fed officials are riding the wave. This week, Fed Governor Christopher Waller said he sold his St. Louis home to a cash buyer without an inspection.
“The national housing market is incredible,” Waller said Monday at a community listening session hosted by the Fed.
It was the Fed’s actions during the pandemic that drove mortgage rates down. The 30-year fixed average bottomed out in January 2021 at 2.65 percent. By cutting the federal funds rate to near zero and buying government and mortgage-backed securities to support the economy, the central bank ushered in an era of cheap home loans.
As borrowing became cheaper, house prices rose as buyers could afford to spend more on housing. The latest Case-Shiller home index showed prices rose 19.2 percent in January from a year earlier. Phoenix, Tampa, and Miami posted gains of 32.6 percent, 30.8 percent, and 28.1 percent, respectively.
Prices should remain moderate, but rising interest rates will continue to make affordability a challenge. And while higher interest rates are expected to slow home buying over time, the factors that led to the housing boom remain. Inventories remain low and demand remains high.
“We’ve already seen a slowdown in buyer activity in terms of fewer home sales,” said Lisa Sturtevant, a real estate market analyst in Alexandria, Virginia. “Part of it has to do with not having enough to buy. I think we’re probably going to see a pretty strong spring as people try to get in before they think rates are going to go even higher.”
As interest rates have risen, the boom in the mortgage market has slowed in 2020 and 2021 this year. Refinancing requests have fallen to their lowest level since 2019. The Mortgage Bankers Association forecasts total applications will fall by more than 35 percent this year. Purchase deals are expected to rise 4 percent, but refinance deals are expected to fall 64 percent.
“The rise in mortgage rates will slow the housing market and further reduce refinancing demand for the remainder of this year,” MBA chief economist Mike Fratantoni said in a statement. “Higher home prices and interest rates, along with continued supply constraints, are now expected to result in an annual decline in existing home sales.”