How Will Rising Mortgage Rates Impact Spring Home-Buying?

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By Mark Flemming, chief economist for First American Financial Corporation

In November, year-over-year nominal house price appreciation reached 21.5 percent, the sixth consecutive month it has set a new record. According to our Real House Price Index (RHPI) - which measures housing affordability based on changes in income, interest rates and nominal house prices - affordability declined 21.0 percent compared with a year ago, as the growth in nominal house prices combined with the 30-basis point increase in the 30-year, fixed mortgage rate vastly outpaced the 4.4 percent increase in income. Affordability is likely to decline further in 2022, because both mortgage rates and nominal house prices are expected to rise.

“While home buyers may have FOMO because of rising rates, they may not want to succumb to the fear of better options, or ‘FOBO,’ because there may be a better home option or options when there’s more homes for sale, even if it means they may pay more.”

Fed Expected to Raise Rates Soon
The Federal Reserve has signaled the end of the easy money era is near. In order to combat inflation, the Fed is expected to increase rates as soon as March. Mortgage rates typically follow the same path as long-term bond yields, which are expected to increase due to the Fed’s tightening of monetary policy, higher inflation expectations and an improving economy. The consensus among economists is that the 30-year, fixed mortgage rate will increase from its November rate of 3.1 percent to 3.7 percent by the end of 2022. Some forecasters predict rates will reach 4 percent, which is still historically low, but well above what buyers have grown accustomed to in recent years.

Rising Mortgage Rates Likely to Reduce Affordability
We can use the RHPI to model shifts in income and interest rates and see how they either increase or decrease consumer house-buying power and affordability. When mortgage rates increase, holding income constant, consumer house-buying power decreases.

If the average mortgage rate remained at its current level of approximately 3.5 percent through the spring home-buying season, assuming a 5 percent down payment and holding average household income constant at the November 2021 level of $69,800, house-buying power falls by approximately $25,000. If rates increase to the anticipated end of 2022 level of 3.7 percent, house-buying power would fall by $36,000. Finally, if mortgage rates reach 4 percent as some industry experts anticipate, house-buying power would fall by nearly $52,000 compared with November 2021.

Rising mortgage rates impact affordability, but one of the root causes of rising mortgage rates is an improving economy, and an improving economy often leads to stronger wage growth. Rising household income can blunt the negative impact that higher rates have on house-buying power. In fact, our estimate of average household income increased approximately 0.6 percent on a monthly basis in November 2021. If incomes continue to increase at this rate through the end of 2022, the income growth would reduce the projected end-of-year 2022 decrease in house-buying power to just $700, instead of $36,000.

FOMO (Fear of Missing Out) or FOBO (Fear of Better Options)?
While rates are expected to increase steadily throughout 2022, many potential home buyers may try to jump into the market now before rates rise further. The fear of missing out, or “FOMO,” on low rates and the potential loss of house-buying power may supercharge the housing market ahead of the spring home-buying season. However, housing supply tends to increase in the spring months as more sellers list their homes for sale. While home buyers may have FOMO because of rising rates, they may not want to succumb to the fear of better options, or “FOBO,” because there may be a better home option or options when there’s more homes for sale, even if it means they may pay more.

For more analysis of affordability, please visit the Real House Price Index. The RHPI is updated monthly with new data. Look for the next edition of the RHPI the week of February 21, 2022.

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