Low rates fueled the revival of the US housing market after the Great Recession and have helped drive home prices to record levels. But after two years of hovering at historic lows, rates have been on a tear: In January, the 30-year fixed average was 3.22 percent. It was 3.04 percent a year ago.
Although mortgage rates were expected to rise, their climb has been faster than many economists predicted. Spurred by inflation, rates have skyrocketed.
Inflation, which has been hitting consumers hard in their everyday lives, also is also causing pain for home buyers. Several months ago, a home buyer would be looking 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 driving the rise in rates. Although the Fed does not set mortgage rates, it does influence them. The central bank took the first steps toward bringing down inflation earlier in March when it raised its benchmark rate for the first time since 2018. In addition to the federal funds rate hike, the Fed is soon to begin the process of reducing its balance sheet.
The Federal Reserve holds about $2.74 trillion in mortgage-backed securities. It indicated it will reveal its plans for reducing its holdings at its May meeting. The more aggressively the Fed sells those bonds, the faster mortgage rates are likely to rise.
The cost of housing doesn’t only weigh on buyers and sellers. It also has proved to be a major complication for the economic recovery, and potentially jeopardizes policymakers’ ability to rein in inflation that has seen through the entire economy.
Inflation is rising at the fastest pace in 40 years, with prices climbing 8.5 percent in March compared with the year before. Shelter is a major part — roughly one third — of the basket of goods and services used to calculate inflation, or what’s known as the “consumer price index.” That means that if housing costs don’t meaningfully turn around soon, it will be that much harder for overall inflation to simmer down to more normal levels.
Shelter costs also stand apart from other categories, such as gas, food or plane tickets, that may be more susceptible to forces like the ongoing pandemic, supply chain disruptions, or a war.
For example, it’s unlikely that gas or energy prices will remain as high as they were when Russia invaded Ukraine and triggered enormous consequences for the world’s energy markets. Food also may become cheaper as supply chains smooth out over time.
But those forces don’t apply to housing costs in the same way. Landlords that can lock in higher rents are unlikely to shave prices a year later. Buyers will continue to clamor for the few homes available. And as the housing market has been supercharged by competitive bidding wars and all-cash offers, it’s unclear how drastically demand will have to cool before the cost of housing will meaningfully turn around.
Even Fed officials are riding the wave. This week, Fed Governor Christopher Waller said that he sold his house in St. Louis to an all-cash buyer with no inspection.
“The national housing market is beyond belief,” Waller said at a community listening session Monday hosted by the Fed.
It was the Fed’s actions during the pandemic that drove down mortgage rates. The 30-year fixed average bottomed out at 2.65 percent in January 2021. By lowering the federal funds rate to near zero and buying Treasurys and mortgage-backed securities to prop up the economy, the central bank ushered in an era of cheap home loans.
When borrowing became less expensive, home prices rose as buyers could afford to spend more on housing. The most recent Case-Shiller housing index showed prices swelled 19.2 percent in January, year over year. Phoenix, Tampa and Miami saw increases of 32.6 percent, 30.8 percent and 28.1 percent, respectively.
Prices should moderate, but rising rates will continue to make affordability a challenge. And though higher rates are expected to slow home buying over time, the factors that have led to the housing boom remain. Inventory remains low and demand remains high.
“We’ve already seen buyer activity slow in terms of seeing fewer home sales,” said Lisa Sturtevant, a housing market analyst in Alexandria, Va. “Part of that has to do with there’s not enough to buy. I think we’re probably going to see a pretty strong spring as people are trying to get in before they think rates are going to go even higher.”
With the increase in rates, the mortgage market’s boom in 2020 and 2021 has slowed this year. Refinancing applications have declined to the lowest level since 2019. The Mortgage Bankers Association is forecasting that overall originations will decline by more than 35 percent this year. Purchase originations are expected to rise 4 percent but refinance originations are predicted to fall 64 percent.
“The jump in mortgage rates will slow the housing market and further reduce refinance demand the rest of this year,” Mike Fratantoni, MBA’s chief economist, said in a statement. “Higher home prices and rates as well as ongoing supply constraints are now expected to lead to an annual decline in existing home sales.”