Mortgage Applications At A Near 30-Year Low – Has The Federal Reserve Gone Too Far? – Yahoo Finance - 24line


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الجمعة، 28 أكتوبر 2022

Mortgage Applications At A Near 30-Year Low – Has The Federal Reserve Gone Too Far? – Yahoo Finance

Almost every day for the last several months, people have been subjected to a steady trickle of bad news about the state of America’s real estate market. Unless you’ve been living under a rock, it’s impossible to avoid talk of the U.S. Federal reserve’s almost yearlong spree of raising interest rates to combat inflation.

Although inflation remains stubbornly high, rate increases have been a drag on the housing market, making people ask, “Has the Fed killed the housing market?” When you look at some of the hard data regarding home sales and mortgage lending, it’s hard not to argue that the Fed has certainly inflicted a deep wound. But has it really killed it?

While it’s true that nobody likes higher interest rates, you can argue that the Fed’s rate increases may be having their desired effect of curbing inflation. Unfortunately, the rates are also having a heavy effect on the housing market. As is the case with any market intervention by the Fed, winners and losers emerge.

How Did We Get Here?

The answer to the question of how the housing market got to this place is relatively simple. After the financial crisis of 2008, the Federal Reserve undertook a policy of quantitative easing. That’s a fancy way of saying it lowered interest rates to the point where it was almost free for banks to borrow money from the Federal Reserve.

The banks then put their borrowed money and the stimulus cash they’d just gotten from the U.S. government out on the streets at incredibly low interest rates. This action served to reheat a housing market that had gone ice cold in the wake of an unprecedented financial crisis that threatened to bring the world’s financial system crashing down on itself.

The Fed’s gambit worked, perhaps a little too well. It wasn’t long before housing prices in America’s top real estate markets exceeded their pre-financial crisis levels. Single-family housing affordability dropped to historic lows in many of America’s major cities at the same time rents were increasing.

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Where The Real Estate Market Is Today

A raft of data supports the idea that the Federal Reserve’s interest rate hikes have put a major kink in the housing market. In the first week of October, mortgages were down 13% from the previous week, according to a study by the Mortgage Bankers Association.

The same study also found that the volume of new applications for home refinancing was down 18% for the same period. Applications for purchase were down 37%, and refi applications were down 86% from a year ago. George Pearkes, who works as a strategist for an investment firm, recently tweeted that he sees the worst housing market since 1994 on the horizon.

It’s impossible not to connect those kinds of dire predictions and the sharp drop-offs in home applications to the fact that the average interest rate on residential mortgages is 6.7%. It hasn’t been that high since 2007, which is right before those rising interest rates created a foreclosure boom that led to the financial crisis of 2008.

The Knock-On Effect

The average 30-year fixed mortgage rate going up to roughly 7% has had a negative effect on consumer buying power. For example, if you start with a $500,000 mortgage at 3% interest (which was not uncommon before the Fed put the squeeze on) for 30 years, you’re looking at about $15,000 per year in interest added on top of the mortgage loan amount.

The annual principal balance on that loan is roughly $16,600 per year or $1,388 per month. Add the interest ($15,000 per year divided by 12 months), and you have another $1,250 per month in interest. So, your total payment (not including property taxes and insurance) would be a $2,638 per month note. If taxes and insurance are $400, you have a house note of around $3,000.

It’s not cheap, but it’s manageable for a two-income family earning a combined $100,000 annually. However, when you push the interest rate up to 7% for the same $500,000 loan, you’re looking at close to $35,000 per year in interest. That’s almost $3,000 a month on top of the $1,250 per month principal, which takes your monthly interest and principal payment up to $4,250.

After property taxes and insurance are calculated, you’re close to $4,500, which basically translates to almost $5,000 a month all-in. The standard threshold for mortgage qualification is three times the monthly note, which means instead of only having to make $100,000 per year to borrow $500,000 at 3%, you’ll need to make $150,000 or more to qualify for the same $500,000 mortgage at today’s current rate of 7%.

Diminished Buying Power

It’s also important to bear in mind that buyers will need good credit to be approved for a 7% (or slightly lower) interest rate, regardless of their ability to qualify economically. It all translates to radically diminished buying power for prospective homeowners.

That’s especially true in major cities like Los Angeles, San Francisco, New York and Boston. The already sky-high home prices in those markets (which were at or near $1 million) was a major factor in motivating people to move to sunbelt cities like Orlando, Tampa, Phoenix and Houston. These cities experienced a housing boom during the COVID-19 crisis, which drove their home prices through the roof.

That was when the Federal Reserve was still keeping interest rates low to keep the economy moving during the COVID-19 crisis. The unintended consequence of such a prolonged period of low interest rates was that a $500,000 mortgage stopped seeming like a whole lot of money. The reality is that $500,000 was always a lot of money. It still is. If prospective buyers weren’t feeling that before, they certainly are now.

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The New Reality

John Adams once said, “Facts are stubborn things.” It was a succinct way of saying that regardless of how people would like for things to be, they are what they are and people have to deal with them. All indications are that the Federal Reserve is planning another rate hike of at least 0.75% next month, which would result in another spike in mortgage rates, credit card interests and any other consumer finance costs.

Higher interest rates appear to be the stubborn new reality that people have to get used to. Even if the Federal Reserve suddenly stopped its rate increases (which is unlikely considering that the European Central Bank and the Bank of England are raising interest rates), the current rate has already taken a big chunk out of consumer buying power.

Could There Be a Greater Good?

On the plus side, unemployment is still low, and some indications point to the possibility that future rate increases by the Federal Reserve (after the next round) may begin to be less severe. Additionally, inflation rates in the United States are at 8.2%, which is high, but significantly lower than the 10.1% in the United Kingdom and the 10.9% in the European Union.

More importantly, the inflation rate in the U.S. was down 0.01% from the previous month, while it’s still going up in Europe and the U.K. Their central banks were much slower to respond to inflation than the Federal Reserve (which took a great deal of criticism for not acting sooner), and their economies are suffering for it.

So, while the Federal Reserve certainly put a giant-sized dent in the housing market, it’s arguable that it may have saved the rest of the economy as a whole in the process. Only time will tell, but if the economy writ large stays strong (and the dollar is trading against foreign currencies at rates that haven’t been seen in decades) with low unemployment, the housing market can only benefit in the long run.

That doesn’t mean there won’t be more pain in the housing sector or the economy as a whole in the short- to immediate-term future. But the reality is that as challenged as the housing market is right now, it would be much worse in the long term if unemployment spiked and inflation continued to grow unabated.

Final Thoughts

The Fed was in the ultimate “damned if you do and damned if you don’t” situation when it came to interest rates and inflation. Only time will tell if it made the right decision, but it had to do something. Unfortunately, raising interest rates was the only lever it had to pull to curb inflation. By the same token, lowering rates is the only lever it has to pull when they need to spur economic growth.

The Fed giveth and the Fed taketh away. Did it hurt the housing market? Undoubtedly yes. Did it kill the housing market? Probably not. Because if history has shown one thing, it’s that the American real estate market always rebounds eventually. Until that happens, the freewheeling real estate market of the mid-2000s is probably over, and everyone is going to have to get used to it.

Today’s Real Estate Investment Insights

  • The investment platform Nada has launched its latest product Cityfunds, the first index-like fund for a single city’s residential real estate market.

  • Arrived Homes has three new vacation rental investment offerings set to go live on its platform with a minimum investment of $100.

Don’t miss real-time alerts on your stocks – join Benzinga Pro for free! Try the tool that will help you invest smarter, faster, and better.

© 2022 Benzinga does not provide investment advice. All rights reserved.

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