Where Can Rates Actually Go?
Freddie Mac recently took a look at the effects of times there were rate increases of at least one full percentage point over the course of at least eight months. As expected, in periods of rising rates:
- Home sales slipped
- Mortgage applications dropped off
- Housing starts stalled
According to Freddie Mac, rising rates on average see home sales drop 5%, housing starts fall 11%, and originations fall 30%. This has happened six times in about the last 40 years. So what might be different about this time?
For one thing, there is pent up demand. While home price increases have outpaced income gains, there still appears to be some demand and homes are affordable to enough potential buyers to sustain the market. Applications to purchase a home are about 3% over where they were a year ago when rates were lower.
Freddie Mac predicts that, “if job growth remains robust and incomes start rising, there’s enough pent up demand that housing markets could post modest growth this year.” That is fine for the short term and may allow for a transition to more reasonable home price increases that are in line with job and income growth. It will also allow consumers to reset expectations of what they can actually afford.
What is different and a significant unknown, this time around, is where rates can actually go. Over the last 40 years, each of the one point hikes in interest rates were followed by periods of rate declines that eventually put us at what are historically low rates. You need to remember that since the early 80’s rates have fallen from the 18% range to the mid 4’s. It is a reasonable assumption that those declines were fairly important to market gains and home sales growth up until the crash about 10 years ago.
If rates go up by a point and stay there what does that do to affordability, sustainability of home prices, the number of current owners looking to move up, and the number of new homes builders are willing or able to bring to the market? Those are variables that will need to be watched closely this time over the rate bump.