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Will Rising Mortgage Rates Squash the Housing Market?

Will Rising Mortgage Rates Squash the Housing Market?

April 11, 2022

Rising mortgage rates alone will not squash the housing market but will definitely slow exuberance

The historic spike in mortgage rates instigated chatter across the country that the housing market is a bubble that will soon pop. Mortgage rates made a steep climb recently as markets reacted to a newly-minted hawkish Federal Reserve (Fed). As seen in the LPL Chart of the Day, mortgage rates rose to levels last seen in 2011. “Our view is the housing market is not necessarily a bubble, but rising rates will no doubt slow some of the irrational exuberance,” says Jeffrey Roach, Chief Economist at LPL Financial. However, we don’t believe headwinds from higher rates will not fully negate the tailwinds of low inventory, pandemic reshuffling, and positive demographics. Other variables would have to turn over before the housing market materially declines.

A 150 basis point rise in mortgage rates is probably not enough to cause severe demand destruction

Several months ago, a prospective homebuyer would pay $1,347 for a $300,000 loan at 3.50%. If the buyer waited until this week to lock in a new rate at 5.00%, the borrower would pay $263 more per month. For most households, an additional cost of $263 per month will cut into discretionary spending, and prospective buyers will reconsider housing options. The initial response to higher rates will be most obvious for first-time prospective home buyers, who will bear the brunt of higher rates. This cohort will likely realign expectations or delay a home purchase altogether. But, those selling a current home could be more adaptable to higher rates, since this cohort can likely offset high costs with existing home equity. Higher cost of funds will likely mean a cut in discretionary items most sensitive to relative price changes. Inflationary periods with high mortgage costs will weigh on the consumer but if rates stay contained, our baseline expectation is the consumer will wade through it.

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Here come the Millennials

Long-term demographic trends will support housing. According to the latest data from the National Association of Realtors (NAR), the median age of first-time buyers has risen to 33.[1] The median age of repeat buyers is 55. The wave of millennials coming into peak buying age and high net worth of the boomers will help support the housing market even though mortgage rates and home prices are rising at an extraordinary pace. Wage growth from a tight labor market also provides support in the near-term. Rising median age of repeat buyers, strong household net worth and low financial debt obligations explain why all-cash sales were roughly 30% of U.S. home purchases in 2021. As borrowing costs increase, all-cash sales will likely rise in 2022.

View enlarged chart.

Years of underbuilding are suppressing housing inventory

Inventory of residential homes is at all-time lows according to Redfin Housing Market data. Other agencies corroborate: at the current sales rate of existing single-family homes, the entire inventory would deplete in less than two months. In some regions, inventory of homes is more scarce. Perhaps some seasoned builders are reluctant to build after experiencing the Great Financial Crisis, but the lack of labor and high cost of raw materials weigh on builders. Therefore, we expect inventory to remain extremely tight, adding support to housing even during times of rising mortgage rates.







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