Updated 4/18/22
To put it mildly, the real estate market has been on fire as of late. In spite of this, we believe it is worth keeping diligent eye on the housing market, as we are seeing some historic movement in mortgage rates. As of this writing, the average rate on a 30-year fixed-rate mortgage is roughly 5%; this is the first time since February 2011 that the average rate has reached 5%. For perspective, the average rate a year ago was just over 3%. However, it’s not just the average rate that has been a notable increase, but also the speed at which these rates have increased.
The average 30-year fixed-rate mortgage at the end of 2021 came in around 3.11%, whereas the first quarter of 2022 ended with an average rate of 4.67%, or a difference of 1.56%. That quarter-over-quarter (QoQ) increase is the third-largest increase since at least 1970, with only Q1 1980 and Q3 1981 having a larger QoQ change. With an increase of this size, we believe it is worth looking into what could be the possible consequences of a rapid ascent in mortgage rates.
Even prior to COVID-19 and the inflation we are seeing today, home ownership had become less achievable for the average American. A recent study by the National Association of Realtors found that the median age of home buyers in 2021 was 45 compared to the median age of 31 in 1981. While there are multiple variables involved, a notable one is economic constraints such as student loan debt that have been felt by younger generations, particularly millennials as they enter into middle age. Add in higher mortgage rates and inflated home prices, and the prospects of home ownership may become even more difficult.
However, even with an average mortgage rate of 5%, there is still one silver lining for the unique economic environment we find ourselves in: negative real mortgage rates. Real mortgage rates are simply mortgage rates minus the current inflation rate. With inflation coming in at -8.5% and the average 30-year fixed-rate mortgage around 5%, this means that real mortgage rates are currently around -3.5%. As strange as it sounds, a negative real mortgage rate means that homeowners are essentially getting paid to borrow money. This phenomenon has been rare in U.S. history, as the most recent occurrence was for a few months between 1979 and 1980.
One other factor to consider is home construction. U.S. housing starts have historically needed to maintain an annualized pace of 1.5 million per year to keep pace with population growth, immigration, and net scrappage. For the past decade, however, the U.S. has been notably under-built in housing. While rising interest rates will impact the costs of construction and developers taking on loans to finance these projects, home construction may be necessary to make up for housing starts lagging the pace of population growth. In short, regardless of higher interest rates, the U.S. needs new homes.
While negative real mortgage rates and the U.S. being under-built may provide tailwinds in the short term, it is still worth being mindful of potential headwinds. The pace of rising mortgage rates has been the highest in at least 40 years, and it doesn’t seem to be slowing down anytime soon. Also, if a combination of further rate hikes and decreased consumer spending occurs, inflation may fall low enough to make real mortgage rates positive again, removing a notable incentive for home buyers. Likewise, saving for a home has already been a notable struggle for current generations, and higher mortgage rates and home prices may continue to price out these prospective home buyers. While we can’t know for certain which scenario will play out, we do believe it is prudent to keep an eye on mortgage rates and their movement moving forward.
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