Mortgage rate climbs to 21-year high, raises housing market crash anxiety

The housing market in the United States is currently facing a critical moment as mortgage rates reach their highest point in past 21 years, since April 2002. This surge in rates, combined with a series of economic factors, has ignited concerns of a potential housing market crash, leaving investors, business leaders, and homeowners wary of the future.

Amidst the backdrop of the Federal Reserve’s assertive monetary policy, the average 30-year mixed mortgage rate has soared to 7.09%, marking a stark departure from the 3% rates observed before the initiation of the Federal Reserve’s tightening cycle in March 22. This rapid escalation in interest payments has prompted anxiety among market observers, recalling previous instances of economic turbulence.

However, it is not just the elevated borrowing costs that are causing apprehension. The discrepancy between average mortgage rates and government-issued bonds has amplified concerns. The significant 277-basis-point spread between 10-year Treasury note yields and the average 30-year mortgage rates represents a striking deviation from historical norms, typically ranging around 1.75 percentage points and reaching as low as 1.3 in 2021. Currently, this mortgage spread has surged to over 3 percentage points. Moody’s Analytics economist Cris deRitis has emphasized the extraordinary nature of this spread, characterizing such divergences as “highly unusual.” Typically, such significant deviations have been observed during periods of substantial financial strain, such as the Great Recession or the early 1980s recession, according to deRitis.

Comparing the present situation with historical patterns further deepens the unease as significant surges in mortgage rates have often presaged economic downturns. In the lead-up to previous recessions, including the turn of the millennium and the early 1980s, there were analogous substantial spikes in mortgage rates, reaching their highest point in modern history in 1981 when the annual average was 16.63%, according to the Freddie Mac data. The unsettling similarity raises concerns about the current stability of the housing market.

As we have witnessed, the evolving trajectory of mortgage rates hinges on a delicate interplay between economic dynamics and Federal Reserve policy decisions. With rates already surpassing 7%, experts are closely monitoring the situation. Lawrence Yun, Chief Economist at the National Association of Realtors, is quoted by MarketWatch as characterizing the 30-year fixed mortgage rate as “at a critical stage.” “If the 30-year-fixed mortgage rate can hold at a high mark of 7.2% — and the 10-year yield holds at 4.2% — then this would be the high for mortgage rates before retreating,” Yun said.

“If it breaks this line and easily goes above 7.2%, then the mortgage rate reaches 8%.”

Past experience has demonstrated the potential impact of such rate hikes. Higher mortgage rates have historically correlated with economic contractions, indicating a potential cooling of the housing market. During the Great Recession, lasting from December 2007 to June 2009, home prices sharply declined, with the S&P/Case-Shiller U.S. National Home Price Index dropping by about 27.4% from its peak in July 2006 to its trough in February 2012. The foreclosure crisis surged, resulting in over 2.8 million foreclosure filings in 2010, an increase of 2 percent from 2009 and 23 percent from 2008, according to data from the website RealtryTrac. Existing home sales plummeted from approximately 7.1 million in January 2005 to around 4.1 million in November 2008, while new housing starts drastically fell from over 2.2 million in January 2006 to about 478,000 in April 2009. Negative equity became widespread, impacting around 26% of mortgaged properties at the peak of the crisis. The downturn led to job losses in construction and related sectors, contributing to overall unemployment during the recession. These factors collectively underscored the profound and far-reaching impact of the housing market downturn on both the real estate sector and the broader economy. This could translate to reduced buyer activity and a decrease in demand for homeownership.

The reverberations extend beyond potential buyers. Existing homeowners now face augmented monthly payments, with the monthly mortgage payment for a median-priced home surging from around $1,100 in early 2019 to over $2,100 today. In a scenario where rates escalate further to 8%, this burden could surpass $2,300, effectively pricing out a significant segment of potential buyers.

However, there exists a segment of buyers who remain relatively resilient in the face of these challenges. Cash buyers, primarily older homeowners who have paid off their mortgages, are better positioned to navigate high rates. This demographic, particularly prominent among baby boomers, can leverage prevailing high rates by selling their homes and redirecting their investments. Their ability to do so without the constraints of mortgage payments contributes to their relative insulation from the market challenges.

However, a housing market crash for some economists appears unlikely due to a number of factors.

• The persistently low inventories, exemplified by the National Association of Realtors’ data showing a 3.1-month supply of homes for sale in June compared to a meager 1.7-month supply in early 2022, suggest that the supply-demand dynamics prevent an imminent price crash.

• Similarly, the measured pace of homebuilding, stemming from the industry’s cautious approach post-previous crash and challenges in land acquisition and regulatory approvals, reduces the risk of overbuilding.

• Demographic trends, such as homeowners seeking more space during the pandemic and the entrance of millennials and Hispanics into prime buying years, contribute to sustained demand.

• Stringent lending standards ensure responsible borrowing, as evidenced by a median credit score of 769 for mortgage applicants in 2023, guarding against artificial price inflation.

• Finally, the housing market is cushioned by limited foreclosure impact, a departure from the post-crash era, as homeowners hold more equity and foreclosure rates remain subdued.

These combined factors underpin the consensus among economists that while affordability concerns persist, the housing market is better equipped to navigate potential challenges and maintain stability.

So, despite these concerns of housing market crash, historical context provides a nuanced perspective. As we look back, historical periods of towering rates and economic uncertainty have been weathered successfully in the past. Unlike the early 1980s, the current inflation landscape is distinct, with the yearly rate of inflation in July measuring just 3.2%. This difference suggests that the current scenario may not necessarily lead to the critical outcomes witnessed during past crises.

In this context, experts say the housing market’s fate is not predetermined; however, its future trajectory remains uncertain, contingent on a range of variables, including Federal Reserve actions, economic growth, and labor market dynamics.