One of the pillars of US economic recovery during the COVID-19 pandemic is beginning to crack.
The glowing US housing market, fueled by record-low interest rates, is one of the most important stories of the past year when it comes to understanding the sharp rebound in financial markets and the relatively pristine condition of many household balance sheets. Freddie Mac’s 30-year fixed-rate mortgage rate started 2020 at 3.72%, just 40 basis points above its all-time low, and fell to 2.65% earlier this year. This decline in the cost of borrowing resulted in all sorts of astonishing numbers: the largest quarterly volume of mortgage origins in history; the highest refinancing in a year since 2003; most debts incurred by first-time buyers in a lifetime; and a collective home equity of $ 182 billion withdrawn in 2020, or an average of $ 27,000 for each household.
These trends are rapidly shifting within a few months of 2021. US mortgage rates are up 3.17% for six straight weeks, their highest level since June. The 50-day moving average was constant at 2.94% for the week leading up to March 25, the first time since the beginning of 2019 that it has not fallen. Other longer-term averages have also plateaued. The message is clear: the absolute low for US mortgage rates appears right in the rearview mirror.
Unsurprisingly, this trend has suppressed the refinancing demand that prevailed throughout 2020. The share of refinancing in total mortgage applications has fallen to 60.9% in seven consecutive weeks, the lowest level since July is only likely to continue. The days can also be numbered for withdrawal refinancing when someone not only lowers the interest rate on their loan but also increases the size of their new mortgage by borrowing against the equity of the home. The $ 152.7 billion created by this practice last year was the highest in US dollars since 2007. My Bloomberg Opinion colleague Alexis Leondis recently argued that this poses a much lower risk than before the housing bubble 14 years ago, but that might not be the case. Rest easy enough to attract those who haven’t requested a refi payout in the past few months.
If that were the end of the story, the outlook wouldn’t be so bleak. After all, 2020 has been such an active year in the mortgage market that it only seems natural to take a breather. Demand for US residential real estate remains solid in a historically strong season. Although new and existing home sales fell and missed estimates in February, both numbers remain at levels not seen before the pandemic since the mid-2000s. Meanwhile, housing starts have declined from the fastest pace since September 2006.
This creates all the necessary conditions for bidding wars. There are only 645,000 homes for sale in the US, according to Redfin, down nearly 50% year over year and the lowest in at least five years. As a result, 36.1% of homes have sold above their list price, which is the highest percentage since at least early 2016. Only a part of the houses had to fall in price as buyers, on average, like to meet sellers on their request, level that is rare. It’s no wonder that S&P CoreLogic Case-Shiller’s US National Home Price Index hit a record high in December, up 10.4% year over year.
Low mortgage rates have certainly helped ease soaring house prices over the past few months. A 50 basis point increase from a record low doesn’t seem like much, especially when the prevailing 30-year rate is still well below a historical average. But it has to sting when placed over much higher home prices and when potential homeowners are increasingly expected to bid above list price, thereby exceeding the upper limits of their target range.
This is what math looks like. The average price for a new single-family home sold in the U.S. hit a record high of $ 356,600 late last year, according to the Census Bureau. At the prevailing 30 year mortgage rate of 2.65%, the annual payment is $ 9,450. In January 2019, when the median fell to a two-year low of $ 305,400, but the average mortgage rate was 4.46%, the annual cost was $ 13,620. With a home price of $ 349,400 and interest rates increasing to 3.17%, the annual payments are $ 11,076.
Of course, early 2019 was the peak of the Federal Reserve’s monetary tightening, and longer-term government bond yields are well below their levels two years ago. However, Chairman Jerome Powell and his colleagues are satisfied with the fact that the yield curve is steepening. A year-end yield of 2% on benchmark 10-year government bonds, currently 1.6%, is increasingly becoming the consensus view on Wall Street. A parallel increase in mortgage rates of 40 basis points at constant average home prices would mean additional annual payments of $ 3,000 compared to the end of 2020.
Perhaps a few thousand dollars in extra interest pales in comparison to America’s excess savings war chest, which Bloomberg Economics valued at $ 1.7 trillion from the start of the pandemic through January. It is also entirely possible that developers will seize the opportunity and increase the supply of housing, or that demand will cool when city centers reopen and tenants no longer feel the need to pay for property in the suburbs.
Regardless, the real estate market doesn’t look like it will provide the US economy and financial assets with the same boost it did last year when Americans made savings through refinancing or hit record lows on their first home, or at least the “wealth effect” increase in value of their existing property. After 12 months of a pandemic, the country could be ready to stand on its own without the support of record-low borrowing costs. But when things wobble, consider mortgage rates the likely culprit.