Are Higher Mortgage Rates a Short-Term Phenomenon?
With the FED intent on raising interest rates at least several times this year, the possibility of lower mortgage levels seems unlikely
The Fed’s decision to raise interest rates had been predicted for months, and now – finally – the first rate increase in three years has arrived. What will this mean for real estate investors and property owners in general?
According to Mike Fratantoni, the chief economist with the Mortgage Bankers Association, the March increase is just the first of a series of expected rate hikes.
The Fed, said Fratantoni, “clearly signaled that additional hikes are coming, with the median FOMC member expecting to raise rates at each of the remaining six meetings in 2022. With the unemployment rate below 4%, inflation nearing 8%, and the war in Ukraine likely to put even more upward pressure on prices, this is what the Fed needs to do to bring inflation under control.”
For real estate borrowers, higher bank rates from the Fed likely mean higher mortgage costs. Rising financing costs are never good news for real estate, but in this particular situation context is important.
Where is the bottom?
The great miracle is not that the Fed has finally decided to raise rates, it’s that rates have steadily trended downhill for decades. Although the journey has had short-term rises here and there, the pattern is fairly plain. We have gone from a monthly rate of 18.45% in October 1981 to a modest 3.76% in February, according to Fannie Mae.
Are there lower rates in our future? Can we ever go back to rates in the 3% range or even 2%?
Not in the short run, but things can change.
In November 2019, VisualCapitalist.com published a remarkable study. It showed that interest rates at the time were at their lowest level in 670 years!
The site also said, “it is clear that the arc of lending bends towards ever-decreasing interest rates, but how low can they go?”
And sure enough, interest rates continued to slide until they reached the 2.65% weekly low seen in January 2021.
Lower mortgage rates today are entirely possible. Overseas, for example, rates have been far-below anything seen in the US. Negative interest actually exists, a reality that has driven cash here and helped US borrowers.
Rising mortgage rates don’t impact everyone
Meanwhile, large numbers of property owners are sitting on the sidelines watching home values rise while mortgage costs remain stable.
“Inflation does not impact everyone equally,” said RealtyTrac Executive Vice President Rick Sharga. “Millions of households have found shelter from rising mortgage rates and soaring prices.”
Who are these lucky people?
According to Sharga, “these are the property owners with fixed-rate financing who have no immediate need to sell, finance, or refinance, individuals who have used residential and investment real estate as a hedge against inflation. Their monthly cost for principal and interest does not change. Their mortgage costs may actually have declined during the past two years through refinancing. They are, in effect, winners in the great inflation derby.”
Moderating mortgage rates
Mortgage rates today are in the high 3% to low 4% range. This is higher than January 2021, but far-below the long-term average. Using Fannie Mae weekly figures from 1971 to the end of 2021, the average mortgage rate was 7.80%, almost twice recent home interest levels.
Although higher rates might seem to be in the cards for the long term, steeper rates much higher than today are not a sure bet.
- Today’s rates would likely be lower had not lenders already anticipated the Fed move and pushed rates higher during the past year.
- Lenders have been holding cash off the market waiting for higher rates. For example, Jaime Dimon, Chairman & Chief Executive Officer at JPMorgan Chase & Co, said in June 2021 that “if you look at our balance sheet, we have like $500 billion of cash and we’ve actually been effectively stockpiling more and more cash waiting for (the) opportunity to invest in higher rates.” (parenthesis mine)
- Commercial banks are swimming in cash. In February 2020 they had deposits worth $13.4 trillion. Two years later, in February 2022, deposits totaled $18.1 trillion. Some of that extra $4.7 trillion, maybe most of it, will slowly move back into the economy in the form of bank loans, debt reduction, and consumer spending.
- Gas prices as this is written, are high — but not as high as a few weeks ago. Lower energy costs reduce inflationary pressures. “Foreign energy imports,” explains Lisa Shalett, Chief Investment Officer, Wealth Management, with Morgan Stanley, “account for less than 5% of total consumption today. U.S. oil drillers are operating only 527 oil rigs in comparison with 1,592 at the peak in 2014. Returning that capacity while improving well productivity could meaningfully offset the current situation.”
- The chip shortage will slowly ease. This will lead to increased auto production and lower vehicle costs, a big reason for rising inflation levels.
- The West Coast shipping backlog – a source of supply chain woes and higher retail prices – will also evaporate as shippers, unions, and the government make a point of unraveling the bottlenecks. This will result in lower prices for a range of goods.
- Inflation, by itself, has a built-in, self-correcting, mechanism that slows spending and consumption. According to Peter Cohan, writing at Forbes, “the Fed’s interest rate increases could cause serious unintended negative consequences – a rise in bankruptcies, lower consumer spending due to the negative wealth effect of declining stock prices, a recession and rising unemployment.”
- We don’t know what will happen in Ukraine at this writing, but a truce of some sort would result in less risk to the world economy, more wheat production, and lower energy costs, all of which would reduce inflationary pressures.
Affordability largely depends on three factors: mortgage rates, income, and home prices. With soaring home prices during the past two years and now, with rising mortgage rates, even generally-rising incomes cannot keep up.
The real affordability issue is not so much rising interest rates as much as the combination of higher rates and soaring home prices. Put together, the combination of these two factors makes affordability more difficult for millions of potential homeowners.
Fewer sales can be one result of reduced affordability and that’s exactly what we’re seeing. January new home sales were 19.3% lower than a year earlier. For existing homes, according to the National Association of Realtors, February sales were off 2.4% from the prior year.
And yet, the market moves forward.
“We’ve seen strong demand for homes and prices rising at previously unfathomable rates. A wave of millennial and baby boomer buyers have depleted housing inventory that was never really replenished following the Great Recession,” said Zillow economist Nicole Bachaud.
We now have a 6.1 month supply of new homes, but new construction prices continue to rise. This is the result of severe supply-chain issues and labor shortages.
With existing homes, the story is different. Homeowners who financed and refinanced during the past two years are likely to stay in place rather than move and finance with more-expensive mortgage loans. This means little inventory will be coming online. Inventory levels in January stood at just 1.7 months. With lots of demand, little supply, and huge numbers of potential buyers, we are likely to see a modest repeat of 2021 – generally higher prices, fewer sales, and rising interest rates – at least until 2023 when the Fed’s efforts to fight inflation start to wind down.
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