Tracy Kidder’s classic 1985 book House follows a Massachusetts couple that has decided to build their dream home. To get the money for the structure itself—not including the land—they must borrow $100,000 at 13 percent interest. It’s a burden that gives the imagined house the special, binding weight of debt. If they pay it off within ten years, they will have wound up giving the bank $80,000 more than they borrowed. If it takes 30 years, the interest on the principal will amount to $300,000. Double-digit interest rates on 30-year mortgages lasted all through the 1980s, and helped prompt the first decline in U.S. homeownership since the Great Depression, the success story in House notwithstanding.
Now, after a decade of cheap money, high interest rates are back. Relatively speaking: Last week, the interest on the average 30-year fixed-rate mortgage hit 6.29 percent, its highest point since 2008. What’s striking is the rate of change: This time last year, the 30-year mortgage rate was 2.88 percent. The cost of borrowing has nearly tripled in 12 months.
There’s no mystery why: the Federal Reserve has been hiking interest rates in an attempt to crush inflation.
What it means for the housing market is less clear. A few days ago, Bloomberg LP chief economist Michael McDonough calculated the affordability shock of rising mortgage rates on top of a huge run-up in home prices in a few big U.S. cities.
This year and last year might as well be in different decades. Nationally, the monthly mortgage payment on the median-price U.S. home has doubled in just two-and-a-half years. It’s the most severe affordability shock on record, writes David Doyle, head of economics at Macquarie. “So if you want to spend $2,500 a month, you can now buy a house that costs $476,425,” Bloomberg’s Joe Weisenthal observes. “For that same monthly payment, you could have purchased a $758,572 house in early 2021.”
Wages aren’t keeping up. Another way to think about this, said Alex Hermann, an analyst at Harvard’s Joint Center for Housing Studies, is that in the spring of 2021, a U.S. household needed an annual income of $80,000 to afford the median home. By this summer, that number was up to $115,000—a 44 percent jump in one year. As a result, the number of renters with the income to afford mortgage payments on the median home has fallen from 10.2 million last year to 5 million this year. And mortgage rates have gone up another point since.
Result: Buyers are dropping out of the market, with the number of pending transactions down by 24 percent since this time last year, according to the National Association of Realtors. Renters may not like the fact that the median rent is up by 20 percent in two years, according to Redfin, but they probably aren’t likely to go house shopping, either. Both because they can’t afford it, and because confidence in the housing market—confidence that you’re making a good investment—is at just 46 percent, according to Freddie Mac, down 20 points from last spring.
The other component is that sellers are locked in. Many sellers are also buyers, moving from one home to the next, and will be comparing available mortgage rates unfavorably with what they’re paying now, and available prices unfavorably with what they paid five years ago. They may choose to postpone a move for as long as they can.
About two in three outstanding mortgages have an interest rate below 4 percent; one in four are below three. Homeowners with such low mortgage interest rates are in “golden handcuffs” Odeta Kushi, chief economist at First American Financial Corp., told the Wall Street Journal. “Congrats to my starter home on its promotion to my death home,” observes one Slate colleague.
This stand-off has been described as a kind of paralysis. Can it last forever? Maybe housing prices will take a significant hit until more buyers can afford them, as homeowners putting off a move find life’s demands—new job, new kid, and so on—become impossible to wait out. Prices have already plateaued, nationally, and in some markets are moderately declining. Home values would have to fall by a third to unlock affordability levels buyers could access as recently as last year.
But maybe they won’t! Daryl Fairweather, chief economist at Redfin, says: “It’s noteworthy how slowly prices have declined. They’re still above last year’s levels. I don’t anticipate any major decline in home prices, unless we enter a recession and interest rates stay elevated.” Some buyers may abandon their search entirely, and throw fuel on the fire currently burning in the rental market, but many will confront sellers’ lack of flexibility by just moving down the price ladder. “Homes that are more moderately priced are still flying off the market,” Fairweather said.
The thing current homeowners have going for them, besides a roof over their heads, low-interest debt, and an asset that has appreciated enormously in the past decade, is that there are structural reasons for the cost of housing to stay high: We haven’t built enough of it to keep up with population growth and family formation as the enormous millennial generation tries to put down roots. Freddie Mac estimates the nation is 3.8 million units short. (Additionally, some research associates high interest rates with rising home prices, because high interest rates are associated with a stronger economy.)
This shortage has its roots in the fact that home construction never recovered from the Great Recession: In the 2010s, the country built fewer new housing units than in any decade since the Great Depression. On a per capita basis, we built less than half as many units in the 2010s as during any of the previous five decades. We built very few of those units in and around the country’s high-wage, high-cost cities. And we built especially few of those units small, despite the fact that family size has been declining for a half-century.
As the United States emerged from the pandemic, housing starts surged, and it looked like we might start to make up the deficit. Not anymore. Homebuilders are holding off; building permits issued in August fell by 14 percent from a year earlier. High interest rates make it expensive for developers to borrow money for big projects, and also reduce the price point they can expect to sell for. To make matters worse, an immigration slowdown has made it hard to find people to build houses—foreign-born workers make up 30 percent of the country’s construction workforce.
So who blinks first, buyers or sellers? In pricey West Coast markets, suggests Jeff Tucker at Zillow, it‘s sellers: even renting out an empty home may not bring in enough cash for sellers to justify deferring a cut-rate sale. Elsewhere, however, and especially in the cheaper Southeast, he said, buyers are meeting high prices. “Homeownership is an aspirational milestone that people are determined to reach, and they may be looking over their shoulder at the rental market and thinking, ‘That’s unpredictable and unpleasant,’” he said.” High inflation, he added, makes any fixed-rate mortgage look more attractive, even at 6 or 7 percent.
One way to see the decline in sales, after all, is glass half-full: The number of buyers is only down 25 percent since interest rates have gone up, even though affordability has fallen through the floor. Still, when mortgage rates go up, historically speaking, the homeownership rate goes down. And that’s not good news for those of us still waiting to get on the ladder.