Persistent rising mortgage rates have stung first-time homebuyers, making it difficult to purchase a house. They have also prevented many homeowners from selling their homes and trading up.
Mortgage rates are rising to new highs, exceeding predictions made in early 2022 as the United States Federal Reserve continues its program of increasing interest rates. The Fed is combatting inflation and, in doing so, making home buying significantly more expensive. The Federal Funds rate has climbed from a range of 0% to 0.25% in February 2022, reaching a range of 5% to 5.25% in September 2023. This unprecedented rapid pace of increases has caused mortgage rates to increase, too.
Mortgage rates today are the highest in more than two decades. According to Freddie Mac, the average 30-year fixed-mortgage rate APR is 7.19%, and the 15-year fixed-rate APR is 6.54%. As recently as late 2021, both rates were roughly 3% or less.
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What Does Rising Mortgage Rates Mean for Homebuyers?
Higher Monthly Payments
The bottom line is monthly payments will be higher. For example, a $400,000 house with a 20% down payment and a 30-year fixed-rate mortgage (FRM) of 4% has a monthly cost of $1,528. The same home bought with a 7% rate has a $2,129 monthly payment, a $601 difference.
As a result, many potential real estate buyers are priced out of the market. A previously affordable house or condominium is no longer attainable. To make matters worse, household incomes have not kept up with rising mortgage rates and home prices. Hence, a greater percentage of take-home pay must be used for monthly mortgage payments. Lastly, the median home price has grown to about $416,100 at the end of the second quarter, a considerable jump from when the pandemic started, further reducing affordability.
Some buyers may be unable to afford the higher monthly payments or qualify for higher-rate mortgages. However, these interest rates are still below the long-term average. Before the Great Recession, historical mortgage rates were usually around 6% or more. Going back further, historical rates were typically 7.5% before the dot-com crash.
Lower Inventory
According to the Mortgage Bankers Association, an estimated 6.12 million existing houses were sold in 2021. Rising mortgage rates caused sales to decline because of falling affordability. Existing home sales volumes fell to 5.03 million in 2022 and are projected to be around 4.0 to 4.5 million in 2023. The levels were last seen during the subprime mortgage crisis and the Great Recession.
Low sales volumes would normally suggest higher inventories. However, inventories have trended down for decades after peaking at 4.04 million units during the Great Recession. Currently, total housing inventories are about 1 million units annually because builders construct fewer homes and prospective sellers stay put.
The bottom line is buyers cannot find homes. Freddie Mac estimates the nation would need an inventory of ~4 million homes to meet current demand. The shortage is a perfect storm between years of underbuilding new homes and first-time buyers entering the real estate market. The result is the lowest inventory in forty years.
The reduced inventory, lower construction, and fierce competition for houses may leave buyers unable to find an affordable place. However, homes continue to sell, and median prices continue to rise nationwide. As a result, first-time buyers are finding themselves stuck in the rental market, which in turn is driving up rental prices.
Look in Different Regions
Prices vary significantly across the country. Moving to a more affordable area and employing a strategy of geographic arbitrage can help new buyers purchase a house, especially with mortgage rates rising so quickly. Some regions may also have greater inventory, with less competition.
According to the Federal Reserve Bank of St. Louis, in Q2 2023, the average median home sale price was $416,100, a 26% increase from the second quarter of 2020. However, the median varies significantly depending on the state.
Based on the Zillow Home Value Index, the least expensive state to purchase a home in was West Virginia, with a typical home value of $155,687. The highest typical value was Hawaii, at $966,572. With a 20% deposit in each state and a thirty-year mortgage at 7%, The monthly mortgage payment would be $1,111 in West Virginia and $5,428 in Hawaii. This difference of $4,317 does not consider real estate taxes, HOA, or homeowners’ insurance.
With the increasing acceptance of remote and hybrid work, workers are no longer required to visit the office daily. These workers are not tied to their current area and can settle in other locales based on different lifestyles and quality of life desires. Many who worked in the cities and rented are now buying houses in the suburbs and exurbs since they no longer commute.
Plan Ahead
Potential buyers should get pre-qualified before looking at houses to help determine their price range and how it fits their budget strategy. Consumers can’t afford to waste time looking at properties outside of their price range in today’s real estate market. An experienced real estate agent and mortgage broker can offer expertise to make the search less painful.
Buyers should bring a larger down payment to make their offer competitive in a tight market and help make their mortgage payment affordable. For example, if you save $10,000 a year, adding more to the down payment, the larger amount will lower the loan-to-value (LTV) ratio, possibly resulting in a lower mortgage rate. Lenders usually view a lower LTV ratio as less risky since buyers will have more home equity. Monies must be in an account for at least 60 days to demonstrate the ability to finance the purchase.
Comparing the different mortgage products is essential and will vary according to finances, income, and credit score. Although adjustable-rate mortgages (ARMs) may be appealing, consumers should examine how the interest rate can change after the fixed-period part of the mortgage. Once the term resets, borrowers may have a sticker shock if the low initial interest rate increases. The initial term is below the market rate on a similar fixed-rate loan.
An ARM may be best for those who cannot qualify for a traditional mortgage and plan to refinance or sell in the fixed-period term. However, the risk of an ARM resetting higher increases in a period of rising mortgage rates, like now, makes them riskier.
Buyers May Need to Wait
Traditionally, the real estate market usually has more houses listed in the springtime. These already-built homes increase inventory and allow first-time buyers to enter the market. Inventories may rise if builders ramp up home starts and completions or prospective sellers list homes. Higher inventories may stabilize prices in some areas.
Next, rising interest rates may stabilize in 2024. After an unprecedented streak of tightening, the U.S. Federal Reserve may pause increases for an extended time. One possible result is stable mortgage rates.
Buyers should stay resilient in a competitive housing market. Flexibility and preparation are essential. People’s intended timelines may work out differently than planned with so many unpredictable variables, but they can persevere and attain the goal of homeownership with time.
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Christine Seaver is a freelance writer that writes about personal finance, budgeting, and debt. She is a frequent contributor at Dividendpower.org. Christine works as an office manager by day and a cookie baker at night. She lives in Massachusetts with her family.