Will Rising Mortgage Rates Squash the Housing Market?

Rising mortgage rates alone will not squash the housing market but will definitely slow exuberance

The historic spike in mortgage rates instigated chatter across the country that the housing market is a bubble that will soon pop. Mortgage rates made a steep climb recently as markets reacted to a newly-minted hawkish Federal Reserve (Fed). As seen in the LPL Chart of the Day, mortgage rates rose to levels last seen in 2011. “Our view is the housing market is not necessarily a bubble, but rising rates will no doubt slow some of the irrational exuberance,” says Jeffrey Roach, Chief Economist at LPL Financial. However, we don’t believe headwinds from higher rates will fully negate the tailwinds of low inventory, pandemic reshuffling, and positive demographics. Other variables would have to turn over before the housing market materially declines.

A 150 basis point rise in mortgage rates is probably not enough to cause severe demand destruction

Several months ago, a prospective homebuyer would pay $1,347 for a $300,000 loan at 3.50%. If the buyer waited until this week to lock in a new rate at 5.00%, the borrower would pay $263 more per month. For most households, an additional cost of $263 per month will cut into discretionary spending, and prospective buyers will reconsider housing options. The initial response to higher rates will be most obvious for first-time prospective home buyers, who will bear the brunt of higher rates. This cohort will likely realign expectations or delay a home purchase altogether. But, those selling a current home could be more adaptable to higher rates, since this cohort can likely offset high costs with existing home equity. Higher cost of funds will likely mean a cut in discretionary items most sensitive to relative price changes. Inflationary periods with high mortgage costs will weigh on the consumer but if rates stay contained, our baseline expectation is the consumer will wade through it.

View enlarged chart.

Here come the Millennials

Long-term demographic trends will support housing. According to the latest data from the National Association of Realtors (NAR), the median age of first-time buyers has risen to 33.[1] The median age of repeat buyers is 55. The wave of millennials coming into peak buying age and high net worth of the boomers will help support the housing market even though mortgage rates and home prices are rising at an extraordinary pace. Wage growth from a tight labor market also provides support in the near-term. Rising median age of repeat buyers, strong household net worth and low financial debt obligations explain why all-cash sales were roughly 30% of U.S. home purchases in 2021. As borrowing costs increase, all-cash sales will likely rise in 2022.

View enlarged chart.

Years of underbuilding are suppressing housing inventory

Inventory of residential homes is at all-time lows according to Redfin Housing Market data. Other agencies corroborate: at the current sales rate of existing single-family homes, the entire inventory would deplete in less than two months. In some regions, inventory of homes is more scarce. Perhaps some seasoned builders are reluctant to build after experiencing the Great Financial Crisis, but the lack of labor and high cost of raw materials weigh on builders. Therefore, we expect inventory to remain extremely tight, adding support to housing even during times of rising mortgage rates.

[1] https://www.nar.realtor/blogs/economists-outlook/age-of-buyers-is-skyrocketing-but-not-for-who-you-might-think#:~:text=The%20number%20that%20has%20changed,to%20a%20number%20of%20factors.

IMPORTANT DISCLOSURES

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.

References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

All index and market data from FactSet and MarketWatch.

This Research material was prepared by LPL Financial, LLC.

Securities and advisory services offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/SIPC).

Insurance products are offered through LPL or its licensed affiliates.  To the extent you are receiving investment advice from a separately registered independent investment advisor that is not an LPL affiliate, please note LPL makes no representation with respect to such entity.

  • Not Insured by FDIC/NCUA or Any Other Government Agency
  • Not Bank/Credit Union Guaranteed
  • Not Bank/Credit Union Deposits or Obligations
  • May Lose Value

For Public Use –  1-05266304