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Why Lower Mortgage Rates Would Cure All That Ails the Housing Market

by Joshua Garcia

The Housing Market: How Mortgage Rates Impact Prices and Inventory

If you ask anyone about the current state of the housing market, you’ll likely hear complaints about high mortgage rates, soaring prices, and limited inventory. What many people fail to realize is that all three of these issues can be attributed to the same underlying cause. The rapid increase in mortgage rates over the past few years has created a logjam in the market, affecting both buyers and sellers.

According to Dean Baker, a senior economist at the Center for Economic and Policy Research, the market has never experienced such a swift rise in rates after a period of record-low rates. This unprecedented situation has locked many homeowners in their properties, reluctant to give up their ultra-low mortgage rates. As a result, there is a severe shortage of properties on the market. The scarcity of available homes, combined with increased demand, has driven prices to new record highs.

The surge in mortgage rates to near 22-year highs has left both buyers and sellers feeling stuck. Affordability for buyers has plummeted to levels not seen since the 1980s. On the other hand, sellers are hesitant to sell their properties as the cost of borrowing for a new home has more than doubled in just two years.

The average interest rate on a 30-year fixed loan dropped to a record low of less than 3% during the pandemic. However, it has since climbed back up, reaching 7%. This rapid increase in rates has created an unprecedented logjam in the market, leaving buyers unable to afford properties and sellers unwilling to part with their low-rate mortgages.

The resolution to this housing market dilemma lies in a significant drop in mortgage rates. However, predicting when rates will decrease significantly is challenging. The trajectory of rates largely depends on perceptions of inflation, an unpredictable factor in itself. Inflation is a key driver of higher mortgage rates, as investors demand higher yields to compensate for the erosion of their returns caused by inflation.

While major housing forecasters predicted a decline in interest rates, they have remained unexpectedly high. The forecast is further complicated by the recent tick-up in inflation, suggesting that the housing market freeze will persist for the foreseeable future.

Comparisons to previous periods of rapid increases in mortgage rates, such as in 1981 when rates dropped by 4.5 percentage points, may not be entirely valid. The starting rate in 1981 was an astonishing 18.4%. Despite this, economists remain cautiously optimistic. Forecasts from Wells Fargo and the Mortgage Bankers Association anticipate a decrease in the 30-year average to the high 5% range by next year.

The “magic number” for breaking the logjam in the housing market seems to be 5%. A decline to this level would improve affordability for buyers and encourage sellers to trade in their low-rate mortgages obtained during the pandemic.

However, mortgage rate volatility is not the sole reason for the sluggishness in home sales. Prices have soared due to a lack of housing inventory and the surge in demand during the pandemic. The shortage of available homes worsened after the 2008 financial crisis decimated many homebuilders.

The reluctance of mortgage holders to sell has contributed to the shortage. Two-thirds of mortgage holders have rates at 4% or below, leading to a significant reduction in available homes for sale. In July, the number of homes for sale was the lowest recorded for any July since 1999.

The limited supply has caused fierce competition among buyers, despite a decrease in overall buyer numbers. According to a survey by the National Association of Realtors, the shortage of affordable choices was the primary reason why buyers couldn’t make a purchase. A drop in mortgage rates would alleviate this obstacle for the majority of buyers.

In conclusion, the state of the current housing market is a result of high mortgage rates, soaring prices, and limited inventory. The logjam created by rapidly increasing rates has left both buyers and sellers feeling trapped. While a significant drop in rates would alleviate some of these issues, it remains unclear when this will occur. Factors such as inflation and market perceptions play a significant role in determining the future trajectory of mortgage rates.

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