The fast 4% mortgage rate climb to 7% has sparked worries about the housing market. However, the residential real estate market produces its own cycles, even running counter to the stock and bond markets. That independence comes from a focus on supply and demand for homes, new and existing.
Then there are the real estate lenders. They are key because most purchases are highly leveraged by long-term debt. The health and price strength of housing (the collateral) and the credit quality of the borrowers (along with current employment factors) are important factors in lenders’ willingness to provide mortgages.
The mortgage rate is where Wall Street comes in. With lenders selling off most mortgages, the current interest rates and investor demand determine the rate offered.
Looking back to understand today’s mortgage rate
Because real estate cycles can be long and have different characteristics, looking at history is a good way to address the question, “Where are mortgage rates headed next?” So, below is a monthly graph starting in 1950.
Why so far back? Because the early 1950s had a good economy with stable, low inflation and bond yields to match. Housing and commercial development were doing well in this post-war period. Residential mortgages began the decade at around 4%. Then came rising inflation.
The first place to look is that 1959 circle where the rate first bumped up to 6% – comparable to today’s mortgage rate. The level was important because investors historically had viewed a 6% yield as safe for a long-term bond. However, 1959 homebuyers considered that rate extreme. Therefore, the 6% rate failed to hold, staying in the 5-1/2% area for the next six years.
Then came the 6% breakthrough without fanfare, thereafter rising steadily for four years up to the red zone – the unheard of 9% to 10% level. Does that mean today’s rates could also reach that level? Probably not. That significant 4% rise began at 5-1/2%. Today’s 4% rise began at 2-1/2% to 3%. Each rise was especially noteworthy, particularly today’s because of its speed. Because such moves spark investor interest (higher money supply) and homebuyer concern (lower money demand), the rise necessarily runs into a ceiling.
History’s bout of high inflation
After hanging around in the low-7% level, the rate ran up again – this time reaching 10% five years after first reaching the 9% to 10% level. Again, though, it fell back, but only to the 9% level.
Finally, four years later in 1979, as stagflation and hyperinflation became heavy concerns, the rate easily broke through 10% for a fast run-up that see-sawed up to 18%.
Using that history for today’s mortgage rate environment
First, today’s 7% level provides no clues by comparing it to the comparable 20-year-old level when rates were falling.
What’s relevant is the run-up to 7% is comparable in size to the ones discussed above. The difference is the higher speed. Importantly, neither the size nor the speed foreshadow a further rise. Instead, as has happened before, heady rises abruptly end and reverse. Why? Because, while borrowers might be wringing their hands, lenders’ and investors’ appetites are whetted. Additionally, all those involved in the selling process roll out strategies that help counter buyers’ concerns (e.g., reduced down payments, adjustable mortgage rates and reduced front-end rates). Finally, there is the powerful force of competition among lenders.
In this market, there also is the change in prospective homebuyer and renter attitudes. Those previous non-buyers could be having a change of heart. If so, they will welcome a less frenzied market, where houses sit for a time and prices fall back from their rapid-rise highs. Higher mortgage rates? As in past periods, homebuyers are focusing on buying a home, so they will be ready to work with the conditions that exist – not remain non-homeowners for the sake of possibly getting a lower cost mortgage while running the risk of house prices rising again.
Two excellent articles from The Wall Street Journal describe how conditions have changed: First, how the market has improved for homebuyers. Second, how the renter boom is beginning to bust.
The bottom line – The real estate market differs from investment markets
Don’t take that 7% mortgage rate as a fixed-income bond selloff. The higher rate is not a stepping stone for higher rates. It’s an invitation for all participants to do something.
That is the residential real estate market at work. The pent-up demand for houses is still there. There simply needs to be a way to get the desired homes into homebuyers’ hands. That is the business of everyone involved in the industry, so have confidence that good things will happen in the housing market.
One very important difference between investors and homebuyers: Investors get nervous when prices fall; Homebuyers get excited. So, it is good news that home prices are now declining.