First-time homebuyers sidelined by higher mortgage rates

Rising mortgage rates are piling onto record-breaking home prices, locking even more potential buyers out of the red-hot housing market. 

The average 30-year fixed rate mortgage rate jumped to 5.3 percent last week, according to data from Bankrate, up from just 3.4 percent at the start of January. Mortgage rates are likely to climb even higher as the Federal Reserve continues with a series of rate increases meant to stanch inflation. 

Home sales began to drop off in March as the Fed began hiking interest rates, boosting mortgage rates along the way. Even so, prices have continued to skyrocket as buyers try to scoop up scarce homes before interest rates climb even higher.  

While mortgage rates are not directly tied to the Fed’s baseline interest rate range, they typically rise and fall based on what banks and lenders expect the Fed to do.  

The Fed is on track to raise its baseline range by another 1.5 percentage points by the end of the year.  

“They’re not going to stop tightening until they’ve kind of reached a reasonable level of inflation,” said Yelena Maleyev, economist at Grant Thornton, in a Wednesday interview. 

Mortgage rates remained low for much of the pandemic as the Fed held its baseline interest rate near zero. While the economy improved rapidly over the past two years, the bank held off raising rates, allowing buyers to afford much higher sale prices with lower monthly payments and interest burdens. 

Higher Fed interest rates should, theoretically, bring housing prices down by reducing the demand for new homes. Rising interest rates historically push more potential buyers to hold off on purchases, and the recent spike in financing terms have already led to a decline in mortgage applications.  

New home sales fell 8.6 percent in March, according to Census Bureau data released last week, and mortgage loan application volume fell 8.3 percent in the week ending April 22, according to the Mortgage Bankers Association’s market composite index.  

The trade group’s purchase index also fell 8 percent after seasonal adjustments. 

“Prospective homebuyers have pulled back this spring, as they continue to face limited options of homes for sale along with higher costs from increasing mortgage rates and prices. The recent decrease in purchase applications is an indication of potential weakness in home sales in the coming months,” said MBA associate vice president Joel Kan in a Wednesday statement. 

But it could be months, if not years, before higher interest rates actually bring housing prices down. 

Soaring demand for homes, driven in part by low Fed interest rates, caused a record-breaking rise in prices. While the pandemic and health restrictions drove more consumers to purchase homes, it also prevented builders from filling a severe shortage of homes that lingered long before the arrival of COVID-19. 

Sale prices for homes rose 20 percent annually in February, according to S&P Corelogic Case-Shiller home price index data released Monday. The combination of higher sale prices and rising mortgage rates pushed the typical monthly mortgage payment to $1,910 in March, according to economists at Redfin, up from $1,423 in March 2021 and $1,280 in March 2020.  

“Housing is significantly less affordable than it was a year ago because the surge in housing costs has far outpaced the increase in wages, meaning many Americans are now priced out of homeownership,” said Redfin deputy chief economist Taylor Marr.  

While home construction has picked up slightly, supply shortages, shipping delays, and lockdowns abroad driven by the pandemic are still major obstacles. Garage doors, windows, siding, and other essential home construction components are still held up in shipping containers and bottlenecks, preventing otherwise ready homes from hitting the market. 

A long-term decline in immigration, restrictive zoning laws and rapid growth in certain regions of the country are also likely to keep housing prices high, Maleyev explained. 

“The Fed hiking and tightening policy right now that’s really targeting demand, but the supply side is just not getting better anytime soon simply because builders cannot build enough homes fast enough,” she said. 

Many prospective buyers could be kept on the sidelines of the housing market and stick with rentals as the U.S. also grapples with soaring rental housing increase. But others are taking the plunge with adjustable-rate mortgages — home loans that may be initially cheaper but are likely to get much more expensive as mortgage rates rise in the near-term. 

The share of applications for adjustable-rate mortgages hit 9 percent, according to MBA data, double what it was in January. 

“That’s kind of an unfortunate story for the first-time homebuyer this year,” Maleyev said.