Just how much trouble is the U.S. housing market in?
Mortgage rates in the United States have risen rapidly. By some counts, this year’s rise from around three percent to 6.75 on the 30-year fixed rate mortgage is the fastest in history. At the same time, home prices have risen at the fastest annual rate ever recorded. The Case-Shiller National Home Price index is up 15.8 percent year over year and 38.7 percent compared with two years ago.
This combination has crushed home affordability. The home ownership affordability monitor maintained by the Federal Reserve Bank of Atlanta sunk below 2007 lows. A year ago in July, the monitor’s index stood at 94.7, just below the 100 mark that the Atlanta Fed says marks the official affordability threshold where housing costs account for less than 30 percent of the median income. This July, the most recent month for which data is available, the index had fallen to 70.4. Between two-thirds and three-quarters of that decline is due to rising interest rates. The index would be down by even more if it weren’t for rising nominal incomes.
Sales have fallen sharply. Through August, existing home sales were down in every month of this year after January. Compared with a year ago, home sales are down 19.9 percent. There was a boom in new home sales in August when mortgage rates briefly dipped back toward five percent, but that is expected to reverse now that mortgage rates have climbed nearer to seven percent. Even with the August burst of sales, however, sales of newly built houses were down slightly from last year.
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The Federal Reserve has made it very clear that it does not foresee cutting its interest rate target next year, which means mortgage rates are likely to stay high. The Fed’s higher interest rate policies are directly aimed at easing labor market tightness and preventing wage pressures from driving inflation higher. So, the income component of home affordability is unlikely to improve either. That leaves just home prices as the lever to restore affordability—leading some to expect home prices will plunge in the months ahead.
That is unlikely. To see why, it helps to remember that the U.S. housing market is supported by the prevalence of a particular type of mortgage that is rare-to-nonexistent in the rest of the world. The 30-year fixed rate mortgage that Americans take for granted is virtually unheard of in most of the world. In Australia, most mortgages are variable rate mortgages. In the U.K., the majority of mortgages are fixed rate but only for two to five years. The average duration is around 3 3/4 of a year, according to research from Bank of America. As a result, around one-third of mortgages need to be refinanced or switched to a variable rate each year.
This means interest rate changes have very different effects in the U.S. than in peer nations. In places where higher interest rates lower the affordability of homes that people have already paid for, there can be forced home sales when people can no longer afford to make their monthly payments. The rush of forced sales weighs down prices—and if rates rise rapidly enough, there’s a risk of a fire sale market sending prices plunging. In the U.S., higher rates and lower affordability mostly just hurts the first-time home buyer market and the refinancing market. Most everyone who already has a mortgage has locked in the lower rates that prevailed earlier.
One result of this locked-in mortgage rate is that people can be locked into their homes. They do not sell their home because the mortgage costs of a new home are too high. In a serious economic slump, especially one that hits some regions harder than others, this can become treacherous because people have trouble moving to where they can find jobs. Typically, however, the dislocation is less. Pity the poor real estate agent. Sales are likely to keep falling because of the lock-in effect. Prices, however, are unlikely to fall by as much because there are fewer homes on the market.
So, the housing market in the U.S. will likely continue to see lower sales, less building, and prices decline from recent highs. But there is unlikely to be a serious plunge unless the economy shrinks far more than expected.