Economic shock to housing market worsens – 6% mortgage rates look close

The good news: the Federal Reserve has the instruments it needs to contain runaway inflation. The bad news: these instruments are, well, blunt and will hit some areas harder than others. Among the most vulnerable: the US real estate market.

Just look at the story. The inflationary period that took off in the 1970s was suppressed by the Federal Reserve. But it wasn’t until the central bank pushed interest rates so high that mortgage rates hit over 18% in 1981. This led to a halving of home building in 1982.

Fast forward to 2022, and the Fed is once again in inflation-fighting mode. Immediately, financial markets began pushing mortgage rates higher. In fact, between December and April, the average 30-year fixed mortgage rate rose from 3.2% to 5.1%.

However, over the past month, this surge in mortgage rates has appeared to level off. It actually fell for a three-week period in May. Well, that was until Friday when it started picking up speed again. The higher-than-expected reading of the consumer price index, which hit a 40-year high of 8.6%, sent turmoil to financial markets. At the end of the day on Friday, the average 30-year fixed mortgage rate stood at 3.85%.

“I don’t think we’ve seen the end of the rise in Treasury yields,” said Mark Zandi, chief economist at Moody’s Analytics. Historically speaking, mortgage rates follow the path of the 10-year Treasury yield. If the 10yr actually goes higher, says Zandi Fortune that we could see mortgage rates go above 6%.

A 2.75 percentage point rise in mortgage rates over the past year, most of which has occurred in the past six months, is historically rare. You would have to go back to 1981 to find the last time mortgage rates rose so quickly.

The rapid rise in mortgage rates has been both an economic shock to the housing market and a blow to homebuyers. If a borrower in June 2021 took out a $500,000 mortgage at a fixed rate of 3.1%, they would see a monthly principal and interest payment of $2,135. At an interest rate of 5.85%, this monthly payment would be $2,950. That’s a 38% higher monthly payment. Over the 30-year loan, that’s an additional $293,264 in total payments.

It is also a bad example. Why? Over the past year, home prices have risen to a record 20.6%. Simply put: a borrower couldn’t get the same house for $500,000 today as a year ago. For this reason, let’s say the $500,000 mortgage jumped 20.6% to $603,000. At a fixed rate of 5.85%, the monthly principal and interest payment on a $603,000 loan is $3,557.

The rapid rise in mortgage rates coupled with the historic rise in US home prices – which have climbed 36.8% since the start of the pandemic – explains why the US housing market is slowing. Many borrowers, who must meet strict lender debt ratios, have lost their mortgage eligibility or simply refuse to shell out that much money. Either way, the US housing market is experiencing what Zandi calls a “housing correction.”

Already, we are seeing existing home sales and new home sales falling rapidly. On Thursday, Freddie Mac’s Deputy Chief Economist Len Kiefer tweeted that falling mortgage applications mean “the US housing market is at the start of the biggest contraction in activity since 2006.”

See this interactive chart on

We are also seeing that cooling drives up inventory levels.

As the housing boom took off during the pandemic, stocks fell to their lowest level in four decades. In March, national inventory levels on Zillow were 64% lower than March 2019 levels. But as the housing market begins to shift into cooling mode, inventory is rising again. Between March 26 and May 7, national inventory levels increased by 10%. This included a 54% increase in inventory in Coeur d’Alene, Idaho, and 49.6% in Reno, Nevada.

“The best part of the housing story in 2022 is the build-up of inventory, because that will put home sellers and builders in check. They had too much pricing power and they pushed prices way too high” , says Logan Mohtashami, principal analyst at HousingWire.

Even though the housing market is cooling, Mohtashami says, there is still too little inventory on the market. Indeed, the vast majority of regional housing markets (see chart below) still have inventory levels more than 50% below their pre-pandemic levels. If mortgage rates start falling again, he says, tight inventory levels could bring the frenzy back.

See this interactive chart on

Is it possible that the housing market can shake off this slowdown and return to boom mode? Zandi doesn’t think so. This housing cooling is intentional – the Fed’s thinking being that if it can slow the housing boom, it can slow inflation. On that front, Zandi says the Fed is likely happy with the housing cooling that began in April.

Going forward, Zandi expects national year-over-year house price growth to stabilize at 0%, and significantly “overvalued” housing markets to see lower house prices. 5 to 10%. Of course, even a 5-10% drop in prices is hardly a financial relief for homebuyers, at least not if mortgage rates actually exceed 6%.

If you’re hungry for more housing data, follow me on Twitter at @NewsLambert.

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