Mortgage Rates Are Crippling the Housing Market

Article originally posted on CoStar on August 23, 2023

One consequence of decades-long, ultra-low interest rates is that many homeowners are locked into cheap mortgages and are unwilling to sell their property if it means having to get a new mortgage with a rate several percentage points higher than their current loan.

It can cost homeowners who have the luxury of currently carrying sub-3% or sub-4% mortgage rates hundreds if not thousands, of dollars per month more to move to an equally-priced home. So it comes as no surprise to read the latest news, provided by the National Association of Realtors, that only 1.11 million existing homes were available for purchase in July.

Adjusting for seasonality, the inventory of homes for sale fell for the sixth consecutive month, and now represents about 3.3 months of supply at the current sales pace. This pales in comparison to pre-pandemic times when existing homes available for purchase averaged 1.75 million.

We might expect those for-sale inventories to grow under one of two scenarios. First, the economy could fall into recession, damaging the labor market and forcing some budget-strained homeowners to put their homes on the market or go into foreclosure. Most market-watchers don’t see this happening, though, because the recent surge in home prices has boosted homeowner equity, allowing strapped homeowners to borrow against it. Foreclosure rates, which have ticked higher recently, are still near historic lows.

Alternatively, inventories might rise if there was a pullback in mortgage rates, as this would reduce the costs sellers face when they themselves take out a mortgage. This seems more unlikely than the first scenario, as weakness in the bond market driven by the federal government’s debt issuance has caused mortgage rates to increasingly move higher. Mortgage rates rose to 7.16% during the week ending on Aug. 11, according to the Mortgage Bankers Association, and are likely heading higher through August. Other estimates of 30-year mortgage rates are currently quoting close to 7.5%, unheard of in almost 23 years.

With fewer homes on the market, transaction activity has been bleak. The Mortgage Bankers Association’s purchase index has fallen by 26% from a year ago and 40% from two years ago. The National Association of Realtors is reporting that sales of existing homes dropped 2.2% in July and were 16.6% lower than a year ago.

Higher mortgage rates and a persistent rise in home prices have eroded affordability since the onset of the pandemic. The National Association of Realtors’ housing affordability index for June, which measures the ability of a typical family to earn enough income to qualify for a mortgage loan to buy a typical home (assuming a 20% downpayment), fell to its lowest levels since June 1985 — even lower than during the Great Financial Crisis. The latest seasonally adjusted reading at 94.7 is likely heading lower as it has not captured the most recent increase in mortgage rates — nor the recent increase in existing home prices, which notched a third consecutive monthly gain in July after seasonal adjustments.

The lack of homes for sale offered by existing homeowners has enticed developers to step in and take on additional projects. Single-family construction starts are ticking higher, reaching an annual rate of 983,000 in July and a 907,000 annual rate for the trailing six-month period.

However, higher mortgage rates are impacting homebuilders as well, as costs for first-time home buyers skyrocket and buyer traffic slows. The National Association of Home Builders (NAHB) Housing Market Index fell sharply in August, erasing gains from June and July. All three sub-indices declined, indicating deteriorating conditions in both the current and future sales environments, as well as lighter traffic of prospective buyers.

More than half of all homebuilders reported offering incentives in August to counteract the impact of higher rates by cutting prices and offering mortgage rate buy-downs. But facing higher construction costs as well as materials and labor shortages, robust demand in the new home market now slowing and is evidently weighing on builder confidence. The index tends to lead housing starts by about six months, indicating that housing starts could change direction later in 2023 and early 2024.

None of this is good news. Many existing homeowners likely want to move but feel trapped by the difference between their current mortgage costs and what they would face in a new home. Many first-time buyers are priced out of the market or are only able to purchase a lower-priced home that is smaller or less-amenitized than they would prefer. Builders face shortages not only of labor and materials but also of lots suitable for new home construction, hampered by zoning restrictions and a burdensome regulatory environment.

Only those homeowners who don’t need a new mortgage to move and buyers with plenty of cash can navigate the housing market these days until rates ease. All eyes are on the Federal Reserve for insight into the timing of that possibility.

Don’t hold your breath.