Higher mortgage rates are coming
What could it mean for prices, homebuyers?
The Federal Reserve’s announcement Wednesday that it will fight inflation by phasing out a bond-buying program and preparing for faster interest-rate hikes will have far-reaching consequences for home prices and affordability, experts say.
The Fed expects to raise rates three times next year, making borrowing more expensive for individuals and businesses, in an attempt to cool down demand and soaring prices. It also expects more rate increases in the following two years, lifting rates from near zero to 2.1% by the end of 2024.
“When the Fed increases its interest rates, banks do, too. And when that happens, mortgage rates go up for borrowers,” says Nadia Evangelou, senior economist and director of forecasting for the National Association of Realtors (NAR).
Evangelou expects mortgage rates to rise to 3.7% by the end of next year.
Home prices have surged to new heights during the pandemic as remote work fueled record demand for bigger houses and buyers took advantage of historically low mortgage rates to finance their purchases.
Those low mortgage rates occurred as the Fed sought to combat a steep economic downturn in 2020 brought about by the COVID-19 pandemic.
During the depths of the recession last year, the Fed cut short-term interest rates almost to zero and bought billions of dollars in Treasury- and mortgage-backed securities each month to support the flow of credit.
The Fed’s intervention pushed mortgage rates to record lows, with the average rate on the benchmark 30year fixed-rate loan slipping to 2.65% in December 2020.
As that was happening, inflation began to emerge in the U.S. economy, sending the consumer price index rising at its fastest pace in almost four decades.
The circumstances now are much different than they were in March of 1982, which is the last time the CPI inflation rate was at 6.8%. Back then, interest on a 30-year mortgage stood at about 17%. As of last week, the rate on a 30-year mortgage was about 3.25%.
What does that mean for home prices in 2022?
The central bank’s decision to plan
for more interest rate increases was not a surprise given the rate of inflation and a booming job market, said Mike Fratantoni, chief economist at the Mortgage Banker’s Association.
“Going forward, MBA forecasts that mortgage rates will rise to 4% by the end of 2022 and may be more volatile as the Fed backs away from the market,” Fratantoni said.
If inflation remains high and mortgage rates rise, it could slow the housing market and put “downward pressure” on home prices, says Leonard Kiefer, economist for Freddie Mac.
On the other hand, with high inflation, asset prices, including real estate, tend to rise.
“So far, it’s been pretty clear that it actually puts upward pressure on house prices,” Kiefer says. “So, the two sort of go against each other,” he said.
Home price increases will likely slow down partly as a consequence of interest rate hikes by the Federal Reserve, said Lawrence Yun, chief economist at the NAR.
Yun expects the 30-year fixed mortgage rate to increase to 3.5% by the end of 2022. But, he said, that would be still lower than the pre-pandemic rate of 4%.
Higher mortgage rates would also erode affordability, with homeowners having to shell out more per month. In its most recent Economic and Housing Market Outlook, Freddie Mac expected the 30-year fixed-rate mortgage to average 3.7% in 2022.
“A homebuyer with a $300,000 mortgage, purchasing that home today at 3.1% with a 30-year fixed would be paying $1,281 a month,” says Kiefer. “By next year, with a 3.7% rate, they would be looking at a $1,381 payment per month.”