The central bank doesn’t directly set mortgage costs, but changes in its policy rate—known as the federal funds rate—ripple through the economy and influence all kinds of lending. Since March, the Fed has raised rates five times, bringing its benchmark rate from near zero to between 3 percent and 3.25 percent. The central bank is expected to raise rates by another 0.75 percentage points next week.
Calculate how much more mortgages will cost as interest rates rise
Those moves have already triggered major consequences for the housing market, and the spike in mortgage rates has prompted some broader concerns that the Fed is pumping the brakes on the economy with far too much force.
“People can say, ‘Well, you know, a percent [added] on the mortgage rate is still low.’ But we’ve had several percents on the mortgage rate in a short period of time,” said Diane Swonk, chief economist at KPMG. “The rapid pace at which they’re raising rates are, in and of themselves, destabilizing.”
The average mortgage rate has gone up dizzyingly fast. A year ago, it was 3.09 percent; even as late as March, the average rate for a 30-year fixed mortgage was below 4 percent. The increase from 3.22 percent in January to 7.08 percent now, a jump of 3.86 percentage points, is the steepest increase rates have gone through in a year. The previous record was 3.59 percentage points in 1981.
Prices rose again in September, ensuring more interest rate hikes
For much of the pandemic, low rates meant aspiring home buyers flooded into the market, competed for the few homes available and sent prices soaring. But now, wary of shelling out hundreds of dollars more per month on a mortgage, buyers are bowing out, boosting the supply of available homes and helping prices go down overall. This year, when rates were below 4 percent, a family earning the median household income of $71,000 could afford a $448,700 home with a 20 percent down payment. This week, with rates around 7 percent, they could only afford a $339,200 home, according to Realtor.com.
Home prices are falling at a record pace. The Case-Shiller home price index released earlier this week showed prices were 13 percent higher in August than they were a year ago, down from 15.6 percent higher the previous month. The 2.6 percentage point difference between those two months is the largest decline in the history of the index, which began in 1987.
Zillow on Wednesday announced it had laid off 300 workers across several departments, including home loans and closing services, though the company said it is not under a hiring freeze.
Demand for mortgages has also plummeted as quickly as rates have spiked. Total application volume is at its lowest level since 1997, according to the Mortgage Bankers Association. Refinances are down 86 percent from where they were a year ago, and mortgage lenders nationwide, including at major banks, have let employees go as the market slows. And rising rates have boosted interest in adjustable-rate mortgages. The ARM share of applications was at 12.7 percent.
Home builders are also being pinched. Overall housing starts fell 8.1 percent to a seasonally adjusted annual rate of 1.44 million units in September, according to a report earlier this month from the US Department of Housing and Urban Development and the US Census Bureau. So far this year, single-family starts are down 5.6 percent compared to this point last year.
Builder confidence also fell for the 10th month in a row in October, dropping to its lowest level since 2012, excluding the two-month period in spring 2020 as the pandemic began. It is half the level it was six months ago.
“This will be the first year since 2011 to see a decline for single-family starts,” Robert Dietz, National Association of Home Builders chief economist, said in a statement. “And given expectations for ongoing elevated interest rates due to actions by the Federal Reserve, 2023 is forecast to see additional single-family building declines as the housing contraction continues.”
Still, the Fed’s tools are limited, and officials routinely point to the housing market as one of the clearest signs that their rate hikes are having the intended effect.
“We are starting to see some adjustment to excess demand in interest-sensitive sectors like housing,” Fed Governor Christopher Waller said in a speech this month. “But more needs to be done to bring inflation down meaningfully and persistently.”
When or how the Fed’s rate hikes rates will overtake inflation elsewhere in the economy is not yet clear. Rate hikes are designed to snuff out demand, but they do nothing to fix supply-side issues, like shortages of oil and gas, affordable apartments or chips for new cars. Overall, consumer prices remain stubbornly high, rising 8.2 percent in September, compared with the year before.
Rent costs are also up 7.2 percent in the past year, and rents pink 0.8 percent from August to September. Goldman Sachs has forecast that overall shelter inflation will peak at 7.5 percent next spring before slowly decelerating to just under 6 percent at the end of 2023. That has major implications for Fed policy, since housing costs makes up a huge portion of the basket of goods used to measure inflation in the economy.
As the Fed fights inflation, worries rise that it’s overcorrecting
But the slowing housing market may also be finally cooling rental prices, too. National rent growth sank at its lowest annual pace (7.8 percent) since June 2021, according to Realtor.com. The US median rental price recorded its second month-over-month decline in eight months in September.
The rise in mortgage rates is slowing down the market even in places where it was red-hot during the pandemic. Through 2020 and 2021, sales prices exploded in the Hudson Valley, as transplants from New York City and elsewhere clamored for the few homes available. But as mortgage rates soar now, the number of homes available has more than doubled in the last three months, jumping from around 150 units to about 380, said Ryan Basten, an associate broker at Berkshire Hathaway HomeServices Nutshell Realty.
That’s an encouraging sign that the market is returning to some version of normal. But Basten said there’s plenty of uncertainty about the future. He ticked through the recent jumps in mortgage rates: 5 percent “wasn’t too bad,” he said, and 6 percent was “workable.” But with the Fed poised to hike rates two more times before the end of the year, Basten said he and others in the industry are left “wondering if there is going to be a real downturn in the market.”
“We can only deal with what we’re dealing with now. I can’t see that mortgage rates are going to go to 10 [percent]. If they did, then that would feel like a recession,” Basten said. “Eight [percent] feels bad. Ten percent would be like, ‘Wow, where do we go from here?’ ”