As home prices continue to grow — albeit at a slower pace — Americans are set to see their purchasing power shrink. And unlike in the past, they won’t be able to rely on falling mortgage rates to bail them out.
The latest edition of the monthly Real House Price Index from title insurance company First American Financial Corp.
showed that housing affordability declined 16.6% over the past year as of August. The report takes into account changes in household income, mortgage rates and nominal home prices when calculating affordability.
In August, nominal home prices rose 20.7% from the previous year, marking the third straight month in which nominal house price appreciation was at a record high. That outweighed the 3.5% increase in home-buying power, due to lower mortgage rates and improved income.
Even though affordability has worsened, when home prices are adjusted to reflect Americans home buying power, they still remain 37.5% below the 2006 peak during the last housing boom.
But an emerging shift in the housing market could make it much harder for people to be able to buy homes. As First American chief economist Mark Fleming noted in the report, since the 1980s the average rate for the 30-year fixed-rate mortgage has trended downwards. He described that trend as “one of the most important driving forces of both purchase and refinance activity for the last 40 years.”
“‘Average mortgage rates won’t stay as low as they are today forever, and as they rise, the decades-long housing and mortgage market tailwind will turn into a headwind.’”
— Mark Fleming, chief economist at First American
“As mortgage rates have drifted lower over the last several decades, borrowers have seen their purchasing power increase, which has facilitated move-up buying, higher housing market turnover (more sales as a percentage of the housing stock) and increased refinancing activity,” Fleming wrote in the report.
That’s likely to change. The overarching expectation across the housing industry is that mortgage rates will increase, particularly as the Federal Reserve stops purchasing mortgage-backed securities as part of its efforts to stimulate the economy amid the COVID-19 pandemic.
The Mortgage Bankers Association, for instance, estimates that the average rate on the 30-year fixed-rate mortgage will rise to 4% by the end of 2022. In 2023 and 2024, the organization predicts that the loan will average 4.3% interest.
Other economists are less aggressive in terms of their outlook on mortgage rates. Fannie Mae, for instance, forecasts that mortgage rates will only reach an average of 3.4% by the end of 2022.
Nevertheless, buyers won’t be able to rely on falling mortgage rates to bail them out if home prices were to rise even higher.
“The Mortgage Bankers Association estimates that the average rate on the 30-year fixed-rate mortgage will rise to 4% by the end of 2022.”
“Average mortgage rates won’t stay as low as they are today forever, and as they rise, the decades-long housing and mortgage market tailwind will turn into a headwind,” Fleming wrote. “Rising mortgage rates, all else equal, will diminish house-buying power, meaning it will cost more per month for a borrower to buy ‘their same home.’”
For a household that makes an average income of around $69,000 and has a 5% down payment saved, an interest-rate increase from around 2.8% to 3.2% by the end of 2021 would equate roughly to a $21,500 reduction in home-buying power. If rates were to hit 3.7% by the end of 2022, according to First American’s analysis, that family would see their home-buying power drop by $49,000.
There is a silver lining potentially, Fleming noted. Mortgage rates are rising in large part because the economy is continuing to rebound. And that should lead to continued wage growth, he suggested.
“Rising household income limits the negative impact that higher rates will have on house-buying power,” he wrote. “Rising rates will lower affordability, but rising household incomes can help to mitigate the impact.”