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Mortgage rates to 7 percent as Fed fights inflation

Becky Enrico-Crum spent much of the pandemic racing to keep up as aspiring homeowners flocked to Idaho. But toward the end of this summer, the president of Boise Regional Realtors felt the frenzy finally ease up.

Prices in the area dropped 4.4 percent between July and August, though they were up 6.6 percent from 2021. Homes now last weeks on the market, as opposed to days. Her clients don’t have to duke it out in fierce bidding wars or scramble to put in all-cash offers.

“We aren’t crashing; we’re leveling out,” Enrico-Crum said. “We’re just trying to find out what that level price is. That’s what everybody is trying to figure out.”

Why does the Fed raise interest rates?

The long-awaited shift — from white-hot housing market to something more normal — is playing out across the country as mortgage rates escalate to the highest levels in 20 years, pushed along partly by the Federal Reserve’s moves to slow down the economy and bring down inflation. The average rate for a 30-year fixed mortgage, the most popular home-loan product, has more than doubled in a year, and many lenders are quoting over 7 percent for such loans. Data to be released Thursday morning by Freddie Mac could also show mortgage rates cresting above 7 percent for the first time since April 2002. A year ago, it was 3.01 percent.

The housing market has been cooling ever since the Fed began raising rates this spring. And it is clearly cooling faster as rates push higher. U.S. home prices slid in July compared to June, marking the first month-to-month decline since January 2019, according to the closely watched S&P CoreLogic Case-Shiller National Home Price Index. In August, existing-home sales fell for the seventh straight month to the lowest level since early pandemic lockdowns, according to the National Association of Realtors. Sales fell 0.4 percent from July to August and 19.9 percent compared to 2021. There are even early signs that rental prices may be easing.

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“It’s really important to look at how much a sector like housing, which boomed coming out of the pandemic, is more vulnerable,” said Diane Swonk, chief economist at KPMG. “It was not only supported by low rates, but it was also supported by the work from home and other shifts. Some of those shifts are not going to go away, but the low rates are.”

Last week, the Federal Reserve hiked rates yet again by 0.75 percentage points, and the bank is expected to hike them twice more before the end of the year. The Fed doesn’t determine mortgage rates specifically, but changes in its benchmark rate — known as the federal funds rate — ripple through the economy and influence all kinds of lending. Since the spring, the Fed has hoisted that rate from near zero to between 3 percent and 3.25 percent, sending mortgage rates on a swift upward streak.

And they might not stop here, especially since the Fed has a long way to go on the inflation fight. Consumer prices unexpectedly rose in August, with rent and food remaining major strains. Stock markets have been tumbling for weeks as policymakers make clear that they are far from seeing the kind of progress they would need to scale their interest rate campaign back, and as central banks around the world hoist rates at the same time.

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Many economists predict a recession later this year or in early 2023, especially since rate hikes operate with a lag and may not fully seize on the economy for months. The housing market reacts very closely to any movement in interest rates. But many other parts of the economy do not.

Asked this week about fears that the central bank won’t have enough time to gauge the impact of rate hikes, Charles Evans, president of the Federal Reserve Bank of Chicago, said, “Well, I am a little nervous about exactly that.

“There are lags in monetary policy and we have moved expeditiously,” Evans said. “We have done three 75 basis point increases in a row, and there is a talk of more to get to that 4.25 percent to 4.5 percent by the end of the year. You’re not leaving much time to sort of look at each monthly release.”

The Fed’s rate hikes are designed to cool demand, and in the housing market, that means culling out buyers who, until just a few months ago, were vying for a handful of houses, sending prices to record highs. Fed officials hope that their policies can slow down the housing market without spurring a crash altogether. Demand for mortgages has dropped as swiftly as rates have risen. Total application volume has fallen six of the past seven weeks, according to the Mortgage Bankers Association. Refinances are off 84 percent from where they were a year ago.

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“The reality that I share with my clients is that people were buying homes when rates reached 7 percent 20 years ago, and they’re going to continue to buy homes when it’s higher or lower,” said Geetesh Kapoor, producing branch manager at Fairway Independent Mortgage Corporation. “If the goal is to buy a home, you can always refinance it later when the rates come down.”

But monetary policy can’t solve the housing market’s other major problem: not enough houses. Low inventory continues to plague the housing market. The lack of homes is exacerbated by homeowners who are reluctant to sell because of their low mortgage rate. According to Black Knight, 90 percent of borrowers have a mortgage rate below 5 percent, and two-thirds have one below 4 percent.

“Many would-be sellers are locked into low rates that make a move up to a much costlier mortgage a difficult transition, keeping inventory low,” said Nicole Bachaud, senior economist at Zillow. “This rebalancing is putting more power in the hands of some affluent buyers who can afford to stay active in the for-sale market, with more time to make crucial decisions, less competition, and more negotiating power than at any time in the past several years.”

Estimates for the shortfall in the country’s housing supply range widely from 1.5 million to 5 million. But it’s clear that home and rent prices will stay elevated until there are more places for people to live.

Rate hikes make closing that supply gap even harder. Phil Crone, executive director of the Dallas Builders Association, said higher interest rates are coming on the heels of persistent supply-chain shortages on anything from windows to garage doors. But Crone hopes the Fed will manage to raise rates and quell inflation without triggering other consequences, like causing businesses to lay people off and make worker shortages in the construction industry even worse — or gut the housing market altogether.

Demand for new homes in north Texas is still strong, especially with the area’s solid job growth, Crone said. There is also a generational component: Many millennials have a de facto fear of high interest rates, but Crone’s parents’ generation are used to much higher mortgage costs. If in the future, inflation comes down and rates find some middle ground, the market will be much more sustainable.

“Right now, it’s just a matter of going from this hyper-acceleration to finding our feet again,” Crone said, “which may make for a bumpy six months or so until we find that.”

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