The good news is that the Federal Reserve has the tools to curb rampant inflation. The bad news: these instruments are, well, compelling and will affect some sectors more than others. Among the most vulnerable: the US real estate market.
Just look at the story. The inflationary period that took off during the 1970s was stifled by the Federal Reserve. But that was only after the central bank pushed interest rates so high that mortgage rates topped 18% in 1981. This saw housing construction halved in 1982.
We are making rapid progress until 2022 and the Fed has returned to the mode of fighting inflation. Financial markets soon began to raise mortgage rates. In fact, between December and April, the 30-year fixed-rate mortgage rose from 3.2% to 5.1%.
However, over the past month, the rise in the mortgage rate appears to have stabilized. In fact, it fell over a three-week period in May. Well, that was until Friday, when it started accelerating again. The higher-than-expected reading of the consumer price index, which reached a 40-year high of 8.6%, put financial markets in distress. At the end of the day on Friday, the 30-year fixed-rate mortgage rate stood at 3.85%.
“I don’t think we’ve seen the end of the Treasury yields increase,” says Mark Zandi, chief economist at Moody’s Analytics. Historically speaking, mortgage rates follow the 10-year Treasury yield trajectory. If the ten-year increase increases, Zandi tells Fortune that we could see mortgage rates exceed 6%.
A 2.75 percentage point increase in mortgage rates over the past year, most of which has occurred over the past six months, is historically uncommon. You should go back to 1981 to find the last time mortgage rates went up so fast.
The rapid jump in mortgage rates was both an economic shock to the real estate market and a major blow to homebuyers. If a borrower in June 2021 took out a $ 500,000 mortgage at a fixed rate of 3.1%, he would see a monthly payment of principal and interest of $ 2,135. At a rate of 5.85%, this monthly payment would be $ 2,950. This is a 38% higher monthly payment. Over the 30-year loan, this is an additional $ 293,264 in total payments.
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This is also a bad example. Because? Over the past year, house prices have risen a record 20.6%. Simply put, a borrower couldn’t get the same house for $ 500,000 a year ago. For this reason, let’s say the $ 500,000 mortgage rose 20.6% to $ 603,000. With a fixed rate of 5.85%, the monthly payment of principal and interest on a $ 603,000 loan amounts to $ 3,557.
The rapid rise in mortgage rates along with the historic jump in home prices in the United States, which have skyrocketed by 36.8% since the beginning of the pandemic, is the reason why the US real estate market is slowing down. Many borrowers, who have to meet strict lender debt / income ratios, have lost their mortgage eligibility or simply refuse to pay so much. Regardless, it has the U.S. real estate market in what Zandi calls a “housing fix.”
We already see that both existing and new home sales are falling rapidly. On Thursday, Freddie Mac’s chief economist, Len Kiefer, tweeted that the downward shift in mortgage applications means that “the U.S. real estate market is in the early stages of further contraction. significant activity since 2006 “.
Check out this interactive chart on Fortune.com
We are also seeing cooling increase inventory levels.
As the housing boom erupted during the pandemic, inventory plummeted to a four-decade low. This March, nationwide inventory levels in Zillow were 64% below March 2019 levels. But as the real estate market begins to shift to cooling mode, inventory rises again. Between March 26 and May 7, nationwide inventory levels rose 10%. This included a 54% increase in inventory in Coeur d’Alene, Idaho, and 49.6% in Reno, Nevada.
“The best part of housing history in 2022 is the increase in inventory, as this will put sellers and home builders under control. They had too much pricing power and they raised prices too much. high, “says Logan Mohtashami, chief analyst at HousingWire.
Even though the real estate market is cooling, says Mohtashami, there is still too little inventory on the market. In fact, the vast majority of regional housing markets (see chart below) still have inventory levels that are more than 50% below their pre-pandemic level. If mortgage rates start to fall again, he says, adjusted inventory levels could see the frenzy return.
Check out this interactive chart on Fortune.com
Is it possible for the housing market to take off this slowdown and return to boom mode? Zandi doesn’t believe it. This home cooling is by design; the Fed’s thinking is that if it can curb the housing boom, it can curb inflation. In this regard, Zandi says the Fed is likely to be happy with the housing cooling that began in April.
Looking to the future, Zandi expects national year-on-year growth in house prices to be steady at 0% and for significantly “overvalued” housing markets to see a 5% to 10% drop in house prices. housing. Of course, even a price drop from 5% to 10% is not a financial relief for home buyers, at least not if mortgage rates exceed 6%.
If you’d like more information on housing, follow me on Twitter at @NewsLambert.
This story was originally presented on Fortune.com