09.06.2023 A noxious blend of inflation and central bank tightening has caused 30-year fixed mortgage rates to spike above 7.5 per cent in the US, their highest level in 22 years. This, in effect, doubles the monthly payment for a similarly sized loan. Rising mortgage rates not only directly affect the housing market, but have second-order economic implications as well.
Notwithstanding higher incomes, our back-of-the-envelope calculation suggests the median home price should be $285,000. That’s 30 per cent below today’s $406,000 median home price. Our median estimate has run consistently above median home prices since 2009, thanks to the Federal Reserve restraining interest rates below fair value. We’re in a rather different world now.
Despite substantially higher financing costs, global home values have remained relatively stable, with the US median home price more than eight per cent higher over the 12 months through March 2023. UK housing has also been resilient, advancing more than five per cent in the interim. Meanwhile, housing in other developed countries has suffered: Canada, down more than 15 per cent; Finland, down 5.6 per cent; and Australia, down nearly four per cent.
That’s because the share of floating-rate mortgages in those countries is high. Between half and three-quarters of Canadian mortgages float, creating payment pressure on existing homeowners. At the same time, the share of adjustable-rate mortgages in the US was only about 10 per cent when the Fed embarked on its rate-hiking program.
Most existing homeowners in the US hold a fixed-rate mortgage, insulating them from today’s higher borrowing costs. The effective mortgage rate for all US housing debt outstanding is 3.6 per cent, according to the Bureau of Economic Analysis. The effective mortgage rate in the UK is 2.9 per cent. The good news: most US homeowners are not adversely affected by rising borrowing costs. The bad news is that they must stay put in their homes in order to benefit. Sales of existing homes have plunged by 2.5 million units annualized since their peak at the beginning of 2021. Sales of new homes, while lower, are rising to satisfy housing demand.
After a COVID-induced lull, household formation is on the rise, driving first-time homebuying demand. Home builders are offering financing incentives to encourage demand.
In the meantime, mortgage activity has plunged in tandem with the slowdown in housing sales. Mortgages for home purchases are half of their pre-pandemic level. Refinance activity is off more than 80 per cent.
Bottom Line: Thanks to the preponderance of fixed-rate mortgages here in the US, housing prices don’t have to immediately respond to higher financing costs. But countries like Canada, Finland and Australia don’t have that luxury, and their economies will suffer accordingly. There are, however, other implications for the US economy. Financial inflexibility can be problematic for homeowners who had routinely refinanced their homes to take cash out against their increased home equity. As recently as March 2022, nearly half of all mortgage activity was existing homeowner taking cash out. That figure has dropped to about 17 per cent as of June and will undoubtedly head lower, leaving less liquidity on household balance sheets. Another implication of homeowners staying put is labor market rigidity: if you can’t sell your house and take on a higher-priced mortgage elsewhere, you can’t move to secure a better, higher-paying job. Slowing labor market mobility has historically dampened productivity and led to higher layoffs and unemployment. Perhaps the expansion of remote work could attenuate that trend. Another possibility is that homeowners could rent out their existing homes. The expansion of rental availability could then put downward pressure on rents.