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Is the housing market about to hit rewind and take us back to the 1980s? According to Wells Fargo, the answer might be a resounding yes. While the broader U.S. economy has shown remarkable resilience despite the constant chatter about an impending recession, the housing market seems to be painting a different picture.
Mortgage rates, currently hovering around 8%, have combined forces with pandemic-induced surges in home prices, creating a perfect storm of housing market instability. The longer these elevated mortgage rates persist, the more prospective buyers are burdened with soaring borrowing costs. In Wells Fargo’s recently released commentary, aptly titled “Rising Borrowing Costs Stand to Tip the Housing Sector Back Into Recession,” economists highlight the looming threat.
For the first time in over twenty years, the 30-year fixed mortgage rate reached this alarming 8% mark in early October. Although there’s hope for rate declines as the Federal Reserve eases its fight against inflation, the cost of financing homes is expected to remain elevated, leaving the prospects of a “housing rebound” looking rather dim.
Drawing parallels between the current situation and the 1980s, Wells Fargo economists Charlie Dougherty and Patrick Barley point to similarities that should concern us all. They join a chorus of voices, including Bank of America Research and First American, in warning about turbulence reminiscent of the ’80s. The ’80s were marked by high mortgage rates as the Federal Reserve, under the leadership of Paul Volcker, grappled with double-digit inflation. It was a time when homebuyers experienced the ’80s déjà vu: high inflation, high interest rates, and a generational shift as millennials transformed into their boomer parents, in terms of homeownership.
“A ‘higher for longer’ interest rate environment would likely not only weigh on demand, but could also constrain supply by reducing new construction and discouraging prospective sellers carrying low mortgage rates from listing their homes for sale,” Dougherty and Barley emphasized.
The impact of rising borrowing costs on affordability is glaring. According to the National Association of Realtors (NAR), the average principal and interest payment for those using a 30-year fixed-rate mortgage increased by a staggering 26% in August compared to the previous year. This rise in monthly payments has far outpaced the growth in median family income, which only increased by 5% over the same period. With mortgage rates continuing to climb from August levels, monthly payments are set to become even more burdensome.
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However, it’s not just elevated borrowing costs that have eroded affordability; soaring home prices have also played a role. Home prices have surged by over 40% since the pandemic’s onset, with consistent increases throughout this year. Tightened supply compounds the problem, as homeowners hold onto their properties to preserve their low mortgage rates, exacerbating the scarcity in an already under-built market.
Wells Fargo expects that if the Federal Reserve sticks to its forecast of lowering interest rates next year, mortgage rates will follow suit. They predict the average 30-year fixed mortgage rate to end this year at 6.94% and drop further to 6.39% in 2024, eventually reaching 5.70% by 2025. Nevertheless, near-term affordability woes caused by elevated mortgage rates are likely to weaken housing activity.
The impact of these factors on existing-home sales has been pronounced, with sales hitting their lowest level in 13 years due to the so-called lock-in effect. However, the decline in sales isn’t surprising, given that housing is one of the most interest-rate sensitive sectors of the economy. The National Association of Realtors (NAR) has even sent a plea to the Fed, urging them to halt interest rate hikes to bolster the housing market, a move reminiscent of the ’80s when homebuilders sent a piece of lumber to the Fed, seeking lower interest rates to revive housing demand.
In summary, while there’s an underlying demand for homes, particularly among millennials in their prime homebuying years, the housing market faces significant challenges ahead. Rising borrowing costs, elevated mortgage rates, and skyrocketing home prices are creating a precarious situation. Still, there’s hope that if the Fed delivers on its promise of lower interest rates, the housing market may find a way out of this ’80s-style crisis.