Waiting for Mortgage Rates to Fall

Buyers got one of the best deals in history when borrowing rates fell to record lows in the early days of the pandemic. Then, as the Federal Reserve began fighting inflation in 2022, mortgage rates skyrocketed, eventually hitting a 20-year high in October. Both groups are sitting on the sidelines, as the majority of homeowners do not want to give up the favorable loan terms they obtained years ago, and prospective buyers simply watch their purchasing power plummet. .

Many potential buyers are now hoping that interest rates will fall again. In a way, their logic makes sense. Everyone talks about the “lock-in effect”. The idea is that mortgage interest rates are so high that would-be sellers don’t put their homes on the market. If interest rates fall, more owners may be willing to make that trade-off. It is also cheaper to borrow money to buy a house. A difference of just a few percentage points in mortgage rates can mean you end up paying hundreds of dollars more each month on a loan related to the same home.

But these observers are missing an important point. When interest rates fall, request Jump up. Buyers may flood the market again, increasing competition and driving prices higher. Over the past decade, there has been a clear correlation between mortgage rates and inventory, with lower mortgage rates reducing the number of homes available for sale at that time. And when interest rates rise, more homes remain on the market and inventory increases.

If borrowing rates end up falling this year, as many expect, it could trigger bidding wars and the kind of frenzied trading that characterized the pandemic-era housing boom. So while it may be unpleasant at the moment, there’s a good chance buyers’ prospects won’t get better anytime soon, and may even get worse.

“Don’t expect lower interest rates to suddenly make it easier for homebuyers,” said Mike Simonsen, president of real estate data firm Altos Research. “You’ll see demand come back quickly and you’ll see increased competition. Then inventory will be low and you’ll be back to a bidding war with all sorts of challenges.”

Basically, it might be a better time to buy a home than you think.

For most potential buyers, the appeal of playing the waiting game lies in the basic math. Suppose he wants to buy a $400,000 home with a 20% down payment and a 30-year loan. According to Freddie Mac, the typical interest rate on its mortgages is around 6.87%, but maybe you have good credit and an enterprising loan officer who will offer you an interest rate of 6.5%. . Even under these generous terms, your monthly payments would be approximately $2,023. Compare this to the fact that about two-thirds of U.S. homeowners have mortgages with interest rates below 4%. Even at the high end of that range, if he took out her 4% mortgage on the same house, his monthly payments would be $1,528, a difference of nearly $500. You don’t get anything extra for that money. You’re not as lucky as someone who took out a loan a few years ago. So waiting until mortgage rates drop certainly seems appealing. The disconnect comes from thinking that if that happens, things will magically get better for the buyer.

Don’t expect lower interest rates to suddenly make things easier for homebuyers.

No matter how weak the market is, hundreds of thousands of American households are looking to change their living situation at any given time for a variety of reasons: marriage, divorce, a better school, or a new job. What is important is the balance between the number of buyers and sellers. A pandemic housing boom occurs when demand dwarfs supply. And if buyers back out, the home will sit longer or the seller will lower the price. That’s why active inventory is so important. When buyers have more options, they can slow down their purchases, thoroughly vet their choices, and maybe even negotiate the price.

However, increased movement does not necessarily increase available inventory. 2021 has been a notoriously tough year for home hunting, with sales reaching the highest level in over 15 years. core logic found. At the same time, the number of homes on the market was at an all-time low. Even during the spring sales season, when more than 1 million single-family homes and condominiums are expected to be on the market at any given time, the number was less than 500,000. Almost as soon as they were listed, the properties disappeared, scooped up by investors, cash-rich retirees, or first-time buyers who were either lucky or desperate, or both. This explains why many dissatisfied homebuyers shared similar sentiments during the pandemic. myself. ”

A similar situation could arise if mortgage rates begin to fall. According to Redfin, there were approximately 665,000 active listings nationwide as of February. That’s a 13% increase over the previous year, but it’s far behind his 1 million-plus homes that went on the market in 2018 and the same month in 2019. Many buyers are taking their time and bidding. More than 60% of prospective buyers say they plan to wait for prices and interest rates to fall before purchasing a home. investigation I found one published by Bank of America last year. And as interest rates fall, more buyers will be able to take advantage of the numbers. John Burns Research and Consulting estimates that for every 1 percentage point drop in mortgage rates, an additional 5 million households will be able to obtain a $400,000 mortgage. So if you think housing inventory will grow even more when interest rates fall, you’re essentially betting that the number of homes on the market will outweigh all of the new demand created.

“I don’t see that happening,” said Alex Thomas, senior research analyst at JBREC. “Too many people are sitting on the sidelines with prices going down. No matter how much inventory goes up, it’s going to overwhelm it.”

A recent report released by the Federal Housing Finance Agency estimates that 1.33 million home sales will be delayed due to rising borrowing rates starting in mid-2022. But many of these phantom sellers also have to pivot and buy another home, so they’re not actually adding to their active inventory. And even if typical mortgage rates were to drop to 6% or 5.5% (way down from typical rates of nearly 7%), people would still be locked in, says FHFA economist Will Dorner. he said. Its effects aren’t going away anytime soon.

Too many people are sitting on the sidelines as prices drop.

“Basically, there are still going to be people who are not going to move, who are not going to give up their home forever,” Dorner said, referring to homeowners with mortgages below 4% or even 3%. he said. “It’s going to take a lot of changes for them to want to get rid of their mortgages.”

But there are other complications with the alternative. If mortgage rates remain stable or even rise, buyers won’t be able to afford as many homes as they could have a few years ago. They simply don’t get much bang for their buck. But if they can adjust their expectations and buy a home, they will trade the pain of today’s higher payments for the benefits of getting on the homeownership ladder. At some point, you might decide to get rid of that mortgage rate and refinance to a better rate.

“So I buy a smaller house, but I still have a chance to buy a house,” Simonsen told me. “But when it’s so hot, he can’t even buy a small house because there are 40 bidders.”

Some caveats to consider here: No one, that is. no one, we can confidently say where mortgage rates will go next — last year, some prominent forecasters bet that regular rates would fall to 5% by the end of the year and instead I saw it reach %. The Fed has signaled plans to lower borrowing rates this year, which will likely push down mortgage rates. But it’s not clear when that will happen. Especially since the economy is still doing better than expected and the Fed remains committed to the future.

While the lock-in effect may be dampening the spirits of both buyers and sellers, it is not the main cause. Federal Reserve Chairman Jerome Powell told a Senate committee earlier this month that things will take care of themselves once the economy (interest rates) normalizes, and that buyers and sellers will eventually accept this new reality and do more trading. suggested that it would start. Rather than focus on interest rates, he pointed to the long-term problem of housing shortages. Yes, more people need to move. But the hard and simple truth is that we really just need more homes.

“People are paying attention to mortgage rates because they hear about mortgage rate changes every week,” FHFA’s Dorner told me. “It’s like a quick fix, like, ‘How do we change mortgage rates? Interest rates go up and down really fast.'” Supply is much more difficult. ”

Even if you believe interest rates will go down, that doesn’t mean you need to buy a home you can’t afford right now. In fact, don’t consider this financial advice. But when deciding whether to buy a home, it’s important to consider the trade-offs. If you’re waiting to take the plunge when interest rates drop, get ready. You might end up throwing elbows with a bunch of other like-minded people.

James Rodriguez I’m a senior reporter on Business Insider’s Discourse team.