Is the Housing Market Going to Crash as Mortgage Rates Approach 8%?

The average 30-year fixed mortgage rate rose to 7.49% from 7.31% the previous week as the yield on the 10-year Treasury spiked to a 16-year high this week. Despite few signs of softening, rates remain at their highest since December 2000 for the second consecutive week.

Homebuyer demand has recently plunged to its worst point since 1996, per the Mortgage Bankers Association (MBA) survey for September 29th. The need for mortgage applications to purchase a home fell by 6% last week to its lowest point in two decades. Overall, purchase demand was 22% lower than the same week a year ago.

However, home prices show no signs of falling. Just as Murat Tasci, Economic and Policy Research Analyst at J.P. Morganstated that,low housing inventory levels could further prevent home prices from declining. The tightness of the inventory is a significant challenge, with NAR's August data indicating only a 3.3-month supply.

Simply speaking, homeowners with low mortgage rates hesitate to sell their homes and return to the market amidst high mortgage rates. In turn, demand from buyers and lack of supply is increasing new home sales and pushing prices even higher.

The US housing market faced a severe downturn from 2005 to 2007, leading to disastrous economic consequences. However, housing economists suggest that while prices may decline, the drop will not be as severe as the one experienced during the Great Recession. The significant difference between then and now is that homeowners' balance sheets are much healthier today than 15 years ago.

Here are the reasons:

1. The typical homeowner with a mortgage has stellar credit, substantial home equity, and a fixed-rate mortgage locked in at a rate below 5 percent. A recent study by Redfin found that 82.4% of all current homeowners have a mortgage rate below the 5% mark.

2. In addition, builders have been cautious about their pace of construction due to their vivid recollections of the Great Recession. Although homebuilding has increased over the past year, it still does not catch up to the pace developers maintained from 2000 to 2006.

3. Before the 2008 financial crisis, home loans were more accessible, as lenders had looser standards for borrowers. They did not verify income and gave loans to risky borrowers, allowing purchases with no down payment. Moreover, they offered adjustable-rate mortgages without a cap on rate increases that ballooned balances.

However, purchasers now face much higher standards when obtaining mortgages. According to economists, even during the pandemic's go-go homebuying years, these high standards remained prevalent. These stringent requirements are a significant difference from the pre-2008 era.

The economists highlighted that household mortgage debt was only 65% of disposable income in Q2 of 2023, compared to a peak of 100% at the start of the financial crisis. Additionally, the ratio of mortgage debt to real estate assets (loan-to-value) was only 27% in Q2 of 2023, significantly lower than in 2010.

4. Moreover, the housing market faced a significant challenge after the housing crash, with millions of foreclosures flooding the market and depressing prices. However, foreclosure activity today remains muted, as most homeowners have built a comfortable equity cushion in their homes.

During the pandemic's peak, lenders refrained from filing default notices, leading to record lows in foreclosures in 2020. While there has been a slight uptick in foreclosures since then, it pales compared to the levels seen in the aftermath of the 2008 financial crisis.

In summary, while home prices continue to stretch the boundaries of affordability, it is improbable that the housing market will experience a crash.

The Bank of America has released its latest projection for the housing market. The report highlights various factors that will hinder the growth of the market. These factors include a limited housing inventory, high prices, and labor shortages. Affordability is a significant concern as home prices grow faster than household incomes. According to the Bank of America note, the median sales price of new single-family homes was more than five times the median household income in 2022.

The Bank of America analysts are cautious about potential turbulence ahead. They suggest that only a rate cut can improve affordability and create a stable and healthy housing market. They anticipate the Fed will raise rates by a quarter-point in November and predict a rate cut of the same magnitude in June next year. By the end of 2024, they expect rates to decrease by three-quarters of a point and another entire point in 2025.

"Until then, hang tight," the researchers wrote about the housing market. "It may be a bumpy ride."