After years of low-and-lower mortgage rates, the 30-year fixed rate shot up from a near-historic-low of 3.35% in early May to 4.46% in late June before settling back to 4.29% last week, according to Freddie Mac . The rate increase was sudden and steep, but not a surprise. Economists and forecasters have been waiting for rates to go up for two reasons: (1) the strengthening economy tends to push up rates, and (2) the Fed is expected to pull back on bond-buying and other measures that have kept rates low, which they reaffirmed in mid-June. By historical standards, rates are still low: remember that mortgage rates hovered around 6% for most of the 2000s, 7-9% in the 1990s, and above 10% in the 1980s. Nonetheless, the recent rate climb has been steep.
What Consumers Think of Rising Rates
Consumers are anxious about rising mortgage rates. Trulia surveyed more than 2,000 people during June 24-26, after rates rose sharply. We asked what their biggest worry would be if they were to buy a home this year. Among all consumers who plan to buy a home in the future, 41% said their top worry is that mortgage rates would rise before they actually bought. The next biggest worries were that prices would rise before they actually bought (37%) and that they wouldn’t find a home for sale that they like (36%).
How high do mortgage rates have to rise before consumers are discouraged from buying a home? Among consumers who plan to buy a home someday, 13% said that mortgage rates of 4% (which is what the rate had climbed to when the survey was conducted) were already too high for them to consider buying a home. Another 20% said they’d be discouraged from buying a home if rates reach 5%; yet another 22% said they’d be discouraged from buying a home if rates reach 6%. Combining these groups, 56% of consumers who plan to buy a home someday would be discouraged from doing so if rates reach 6%. Among renters who plan to buy a home someday, 62% would be discouraged from doing so if rates reach 6%.
Watch What They Do, Not What They Say
Consumers are right to worry about the effect of mortgage rates on housing costs. Higher rates, of course, raise the monthly mortgage payment for a loan. For instance, at 3.35% the monthly payment on a $200,000, 30-year fixed-rate loan is $881; at 4.46% the payment jumps to $1009 – that’s a 14% jump in the monthly mortgage payment between early May and late June. This means a consumer can afford less house for a fixed monthly payment, which – all else equal – should reduce housing demand and home prices in the long term. In the short term, however, if consumers expect rates to rise further, some might rush to buy, which could boost sales and home prices temporarily.
However, in the recent run-up in rates, not much has happened to either prices or to home-purchase mortgage applications. Trulia’s Price Monitor, which is the earliest indicator of price trends available, shows that asking prices in June rose 1.5% month-over-month – showing no signs of a slowdown while not spiking much above price gains in the previous few months. Nor is there any sign of either a slowdown or a spike in mortgage applications by prospective homebuyers, either: the Mortgage Bankers’ Association (MBA) index for home-purchase mortgage applications in June rose 2% month-over-month and 11% year-over-year (comparing 4-week moving averages).
So far, the biggest impact of higher mortgage rates has not been on home purchases, but on refinancing. The MBA’s refinance mortgage applications index in June fell 24% month-over-month and 40% year-over-year. Unlike buying a home, refinancing is a purely financial decision that people can do relatively quickly, so the impact of rising rates on refinancing is sharp and almost immediate. Both low mortgage rates and expanded eligibility rules for government-sponsored programs have encouraged refinancing over the past couple of years, which lowered borrowers’ monthly payments so they had more money left over to spend or save. With rising rates, though, few people who haven’t refinanced already will do so now.
What Effect Will Rising Rates Have?
Rising mortgage rates are making consumers nervous and discouraged. Higher rates make housing less affordable and should help slow home price gains from a rapid boil to a gentler simmer. But so far, the effect of rising rates on the housing market – aside from the drop in refinancing – has been limited and is unlikely to derail the housing recovery. Why? Four reasons:
Mortgage rates are rising alongside a strengthening economy, boosting housing demand. By themselves, rising rates make housing more expensive and hurt housing demand. But rates aren’t rising in a vacuum. After a severe recession, economic recovery tends to push interest rates higher as demand for credit increases and investors worry more about inflation. Furthermore, the Fed has tied its plans to taper bond-buying to signal that the economy is getting stronger. Therefore, by design, the strengthening economy should boost housing demand at the same time that rising rates dampen housing demand.
Inventory remains tight, making it hard for homebuyers to rush their purchase. Even though the number of homes for sale has recently started to increase, inventory remains tight. That means buyers who want to find and buy a home quickly to beat rising rates might be held back by slim pickings. In fact, among survey respondents who actually plan to buy a home within the next year, not being able to find a home they like edges out rising mortgage rates as their #1 worry.
Rising rates could lead to expanded mortgage credit. Mortgage rates matter – but only if you can get a mortgage in the first place. Although credit might be starting to open up for the most qualified buyers, credit remains tight. But rising rates could have a silver lining: as refinancing demand dries up, banks might look to expand their home-purchase lending instead. When rates were at their low point last fall, refinancing accounted for more than 80% of mortgage applications, so the recent drop in refinancing leaves a big hole in banks’ mortgage business that home-purchase loans could fill. Even though consumers are anxious about rising rates, we bet they’d rather have a 5% loan that they can actually get than a 3.5% loan they can’t get.
Buying is still a lot cheaper than renting. There’s no question that rising rates make home-buying more expensive than it was a few months ago. But we can’t turn back time: the choice is not to buy now or six months ago. Rather, the choice that many consumers face is whether to buy or rent today at current prices, rents, and mortgage rates. Right now, that math still makes buying look like the better deal – by far. Even with a 4.5% 30-year-fixed mortgage, buying is 37% cheaper than renting nationally; that’s because a 4.5% rate is still very low by historical standards, and prices are still modest relative to rents. Nationally, renting doesn’t get cheaper than buying until rates reach 10.5%, though the tipping point is below 6% in the Bay Area and Honolulu.
Overall, rising mortgage rates will help slow down recent home price gains and should help the market avoid veering into bubble territory. Rising rates will put homeownership out of reach for some consumers, but the strengthening economy and the possibility of easier mortgage credit could keep some discouraged homebuyers in the game.