The central bank does not directly set mortgage costs, but changes the policy rate – known as the federal funds rate – ripples through the economy and affects all types of lending. Since March, the Fed has raised interest rates five times, bringing the reference rate from close to zero to between 3 percent and 3.25 percent. The central bank is expected to raise interest rates by a further 0.75 percentage points next week.
Calculate how much more mortgages will cost when interest rates rise
These measures have already triggered major consequences for the housing market, and the increase in mortgage interest rates has had some effect broader concern that the Fed is slowing the economy with far too much force.
“People might say, ‘Well, you know, one percent.’ [added] on the mortgage interest rate is still low.’ But we have had several percent on the mortgage interest rate in a short time, says Diane Swonk, chief economist at KPMG. “The rapid pace at which they are raising interest rates is in itself destabilizing.”
The average mortgage interest rate has gone up dizzyingly quickly. A year ago it was 3.09 percent; even as recently as March, the average interest rate for a 30-year fixed mortgage was below 4 percent. The increase from 3.22 per cent in January to 7.08 percent now, a jump of 3.86 percentage points, is the steepest increase seen in a year. The previous record was 3.59 percentage points in 1981.
Prices rose again in September, which led to several interest rate increases
For much of the pandemic, low prices meant hopeful home buyers flooded the market, competing for the few homes available and sending prices skyrocketing. But now, wary of shelling out hundreds of dollars more per month on a mortgage, buyers are buckling down, increasing the supply of available homes and helping prices drop overall. This year, when rates were below 4 percent, a family earning a median household income of $71,000 could afford a $448,700 home with a 20 percent down payment. This week, with prices around 7 percent, they could only afford a $339,200 house, according to Realtor.com.
House prices are falling at record speed. The Case-Shiller home price index released earlier this week showed prices were 13 percent higher in August than they were a year ago, down from 15.6 percent higher the month before. The 2.6 percentage point difference between those two months is the largest decline in the history of the index, which debuted in 1987.
Zillow announced Wednesday that it had laid off 300 workers across several departments, including mortgage and closing services, although the company said it is not under a hiring freeze.
Demand for mortgages has also fallen as quickly as interest rates have risen. Total application volume is at its lowest level since 1997, according to the Mortgage Bankers Association. Refinancing is down 86 percent from where it was a year ago, and mortgage lenders across the country, including at major banks, have let go as the market slows. And rising interest rates have increased interest in mortgages with adjustable interest rates. The ARM share of applications was 12.7 per cent.
Home builders are also squeezed. Overall housing starts fell 8.1 percent to a seasonally adjusted annual rate of 1.44 million units in September, according to a report earlier this month from the U.S. Department of Housing and Urban Development and the U.S. Census Bureau. So far this year, single family starts are down 5.6 per cent compared to this point last year.
Builder confidence also fell for the 10th consecutive month in October, falling to the lowest level since 2012, excluding the two-month period in spring 2020 when the pandemic began. That’s half the level it was six months ago.
“This will be the first year since 2011 to see a decline for small family starts,” Robert Dietz, the National Association of Home Builders’ chief economist, said in a statement. “And given expectations of ongoing elevated interest rates due to actions by the Federal Reserve, 2023 is forecast to see further declines in single-family homes as the housing contraction continues.”
Still, the Fed’s tools are limited, and officials routinely point to the housing market as one of the clearest signs that their rate hikes are having the intended effect.
“We’re starting to see some adjustment to excess demand in interest rate-sensitive sectors like housing,” Fed Governor Christopher Waller said in a speech this month. “But more needs to be done to bring inflation down meaningfully and sustainably.”
When or how the Fed’s rate hikes will overtake inflation elsewhere in the economy is not yet clear. Interest rate hikes are designed to stem demand, but they do nothing to fix supply problems, such as shortages of oil and gas, affordable housing or chips for new cars. Overall, consumer prices remain stubbornly high, and rose 8.2 per cent in September, compared to the previous year.
Rental costs have also increased by 7.2 per cent in the past year, and rents rose 0.8 per cent from August to September. Goldman Sachs has forecast that overall inflation will peak at 7.5 percent next spring before slowly slowing to just under 6 percent by the end of 2023. That has major implications for Fed policy, since housing costs make up a large part of the commodity basket is used to measure inflation in the economy.
As the Fed fights inflation, concerns are growing that it is overcorrecting
But the slowing housing market may also finally cool rental prices as well. National rent growth fell to its slowest annual pace (7.8 percent) since June 2021, according to Realtor.com. The US median rent posted its second month-over-month decline in eight months in September.
The rise in mortgage rates is slowing the market even in places that were red-hot during the pandemic. Throughout 2020 and 2021, sales prices exploded in the Hudson Valley as transplants from New York City and elsewhere clamored for the few homes available. But with mortgage rates rising now, the number of available homes has more than doubled in the past three months, jumping from about 150 units to about 380, said Ryan Basten, an associate broker at Berkshire Hathaway HomeServices Nutshell Realty.
It’s an encouraging sign that the market is returning to some version of normal. But Basten said there is a lot of uncertainty about the future. He cruised through recent jumps in mortgage rates: 5 percent “wasn’t too bad,” he said, and 6 the percentage was “feasible”. But with the Fed poised to raise rates two more times before the end of the year, Basten said he and others in the industry “wonder if there’s going to be a real downturn in the market.”
“We can only deal with what we are dealing with now. I can’t see mortgage rates going to 10 [percent]. If they did, it would feel like a recession, Basten said. “Eight [percent] feels bad. Ten percent would be like, “Wow, where do we go from here?” “