By: Leslie Cook
After years of decreasing mortgage rates, buyers are now facing rates above 4% for the first time since before the coronavirus pandemic. While sub-3% rates were initially a boon for homebuyers and refinancers, higher rates could be a blessing in disguise for an overheated housing market.
Since the start of the year, Freddie Mac’s benchmark rate has shot up by more than 1 percentage point. The current mortgage rate of 4.16% is the highest 30-year average since May 2019.
Most homebuyers expect rates to go even higher. Sixty-seven percent of respondents in Fannie Mae’s recent Home Purchase Sentiment Index said they expect mortgage rates to keep increasing throughout the year.
While higher rates will certainly put a new crimp in housing affordability, they could be a silver lining for the housing market in general. That’s because the abrupt increase in rates is arriving amid a highly competitive market with very low inventory and record high home prices.
“Rising rates may help tamper down demand somewhat to the point that it would help the housing market look more normal,” says Ralph McLaughlin, chief economist at Kukun, a real estate and data analytics company. “Because we are certainly in an extremely abnormal market.”
1. Slower home price growth
Last year, home prices increased by nearly 20%, driven by a lack of supply and high demand. Now, as rising rates make monthly mortgage payments less affordable, home price growth could cool down as a result.
According to Taylor Marr, deputy chief economist for brokerage Redfin, there is a historic correlation between rising interest rates and lower home price growth. In a typical year, if mortgage rates increase by 1% there tends to be a 5% drop in price growth. (Note, this is not a drop in actual price but in the pace at which sales prices increase.)
This time, the market hasn’t seen that effect yet. In fact, the abrupt increase in interest rates has so far actually led to a spike in demand as buyers rush to lock in rates before further increases.
However, as interest rates move higher at a more measured pace, as is expected by most market observers, those higher rates should start to slow price growth as well.
“The market was in need of higher rates in order to sort of balance out how much prices have grown,” says Marr.
2. Less competition
Higher rates mean that some potential homebuyers will be priced out of the market. This is bad news for those people, but good for the buyers that remain.
The average mortgage payment for a newly listed home is up 25% compared to mid-March last year, notes Marr. At the current rate, the monthly mortgage payment on a typical home is at an all-time high of $2,123.
Marr believes that as rates begin a slower and more controlled ascent later this year, some buyers will need to take a step back.
3. More housing stock
As demand slows, homes should stay on the market a little longer, giving inventory a chance to build and easing the supply crunch a bit.
In February, there were already signs of a slight improvement in the housing supply as evidenced by a smaller decline in active listing compared to last year. While no one is expecting a flood of homes to miraculously appear and wipe out the housing deficit, the signs are encouraging.
“All we really need is listings to be on par with demand and then the market to slow a little bit to get that inventory build-up that would be a more balanced and healthy market,” notes Marr.
4. Better savings rates
Home prices aren’t the only economic indicator increasing rapidly. In February inflation reached 7.9%, the highest rate of consumer price growth in 40 years. The war in Ukraine and the resulting sanctions on Russia threaten to boost inflation even further, particularly the ban on oil imports that is already pushing gas price higher.
At the March meeting of the Federal Open Market Committee, the Federal Reserve announced a 0.25 percentage point increase in the federal funds rate, which is essentially the price banks loan each other money at short-term. The central bank also indicated an additional 6 hikes are likely through the year.
In theory, rising the federal funds rate will slow down the economy by making it harder for both businesses and consumers to borrow money — including for houses — lowering demand and eventually leading to lower costs on a number of goods and services.
Higher rates also mean that banks should eventually pay higher interest on savings products, encouraging consumers to save and accumulate wealth. So for homebuyers, there is a tradeoff. Mortgage payments may be higher, but in theory other costs will be reduced and the savings rate will increase.
How high do rates have to go before they become a problem?
Some borrowers are already facing affordability issues with mortgage rates above 4%, but the experts we spoke to believe rates still have room to go up before hurting the overall market. At around 5%, however, some say rates may start to have a more widespread impact.
“We’ve been in such a low rate environment with rates below 5% for so long,” says Melissa Cohn, regional vice president at William Raveis Mortgage. “Psychologically, that [number] can become a barrier.” Rates last crossed above 5% in 2010.
Mortgage rates would have to increase as high as 7% to 8% for a sustained period before home prices might actually start to decline, says McLaughlin. For now, remember that while rates are not as low as they were a year ago, “They’re still pretty darn good,” he says.
Source: https://money.com/reasons-higher-mortgage-rates-good-homebuyers/