Updated: Nov 13
NOTE: THIS IS PART ONE OF A THREE PART SERIES. TODAY WE ARE ADDRESSING MORTGAGE RATES, AND HOW THEY COULD IMPACT THE VALUE OF YOUR HOME. WE WILL ADDRESS INTEREST RATES AND THEIR POTENTIAL IMPACT ON THE ECONOMY AND YOUR SAVINGS IN PART 2. READ PART TWO HERE AND PART THREE HERE.
Since 2020, home prices have risen 30%, but household incomes have only risen 13%. While families that have a lot of wealth can afford the higher cost of housing, eventually the rest of the home purchases need to come from ordinary American families. And most families cannot afford the current price of housing.
So what comes next?
Housing affordability is driven by three factors: Household Incomes, Home Values and Mortgage Rates.
Household incomes have not risen enough to keep up with the aggressive increase in housing prices, so that does not bode well for the housing market.
And what about interest rates?
Mortgage rates had been steadily declining since the early 80’s, but they appear to have bottomed in 2021, and have risen aggressively since then.
MORTGAGE RATES OVER THE PAST 40 YEARS
Since January of 2021, when the 30-year fixed rate mortgage plunged to 2.65%, mortgage rates have tripled to nearly 8% (see Graph 1 at the bottom to observe the progression of mortgage rates over the past three years).
What does that do for housing affordability?
Back in January of 2021, a $400,000 thirty-year fixed-rate mortgage would have required a monthly payment of $1,612 (with a 2.65% interest rate, excluding property taxes). That same mortgage today requires a monthly payment of $2,921 (with a 7.95% interest rate), nearly double the payment to simply afford the higher mortgage rate.
What about home values?
According to the Federal Reserve Bank of St. Louis, home values are just starting to decline. Peaking in the fourth quarter of 2022, home prices dropped over $50,000 in the first quarter of 2023 (see Graph 2 at the bottom to observe the progression of housing prices over the past three years). That’s still a 32% increase from where we were just three years ago, when mortgage rates were below 3%.
Combining the aggressive appreciation of home prices with the significant rise in mortgage rates means that the average American family will see a mortgage payment that is more than twice what it was in 2020 (see Note 1 at the bottom).
Can home values remain where they are?
When families are forced to spend the lion’s share of their household income on mortgage payments and grocery bills, there is less discretionary spending available to support economic growth. Unless household incomes rise dramatically, or mortgage rates drop significantly, home values are simply unsustainable in the current environment.
It’s all about demand
It’s all about the law of “Supply and Demand.” Keeping demand constant and increasing the supply leads to lower prices.
The volume of existing home sales has already dropped to levels that we have not seen in two decades. (SEE GRAPH 3 BELOW – The Existing home sales graph).
The REFI Index is widely seen as a leading indicator to future home sales, and it is near 20-year lows (SEE GRAPH 4 - REFI INDEX ). This means the pipeline for future sales is even less optimistic.
But the greatest risks to housing prices is rising inventory levels (SEE GRAPH 5 BELOW to observe housing inventory over the last 7 years).
It was easy for housing prices to go through the roof in 2021 and 2022, when the demand was incredibly high and supply was incredibly low. Demand was off the charts because mortgage rates were near all-time lows. Mortgage rates today are at levels that have not been seen in nearly two decades.
So what will happen if supply begins to come back on the market, and there is no demand?
Yes, there is shadow demand, with a bunch of first-time home buyers anxious to buy. But when the monthly payment is $2,900, it might make more sense to rent. Especially when the average new mortgage payment is 52% higher than the average apartment rent (according to CBRE).
How Does This All Impact Me?
The supply side of housing could remain tight. With nearly 80% of homeowners having locked in their mortgage rate below 5%, many of these homeowners could stay put, unwilling to forgo their cheap financing in pursuit of a different home at much higher mortgage rates. But the convergence of high home values, high mortgage rates, and limited income growth does not bode well for the price of housing.
No one can predict the future, but home values are unsustainable when housing is not affordable. Should demand begin to dry up, the supply side may continue to grow, and sellers may be forced to react by dropping prices.
If housing prices drop to levels where the average American family can afford them, then the market will come back into balance. Unless the Fed reverses course, and begins to focus on lowering borrowing costs, we believe that balance will be below today’s current home values.
GRAPH 1: MORTGAGE RATES OVER THE PAST 3 YEARS
GRAPH 2: HOME PRICES OVER THE PAST 3 YEARS
GRAPH 3: EXISTING HOME SALES
Source: Tradingeconomics.com / National Association of Realtors®
GRAPH 4: REFI INDEX (widely seen as a leading indicator to future home sales)
Source: Tradingeconomics.com / Mortgage Bankers Association of America
GRAPH 5: HOUSING INVENTORY
Source: Fred.stlouis / Realtor.com
Note 1: Assumptions:
1) 20% down on purchase of average-priced home in 2020
2) Monthly mortgage payment of $1,266 (excluding their property tax bill in 2020).
3) 20% down on purchase of average-priced home in 2023
4) Monthly mortgage payment of $2,921 (excluding tax bill in 2023)
That is more than twice the mortgage payment from three years ago, for the same home, and another $1,655 coming out of household budgets every month to simply afford today’s housing at today’s prices and today’s mortgage rates.
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