Stuck: Ultra-low rates are anchoring the housing market
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The housing market remains a puzzle in 2024. While headlines focus on rising interest rates and a potential cooling-off period, there’s a hidden force impacting the market: millions of homeowners are locked into incredibly low mortgage rates from the pre-2023 era. This creates a unique situation where many people hesitate to sell, impacting buyers and sellers.
How are low rates the culprit?
Let’s break down the situation. When mortgage rates were hovering around historic lows in the early 2020s, many homeowners jumped at the chance to refinance or purchase a home. These rates, significantly lower than those currently offered, mean much lower monthly payments. For instance, just a few years ago, it was common for someone to snag a 30-year mortgage in the 2%-3% range. On a mortgage with a balance of $300k, individuals with a 3% rate have a monthly principal and interest payment of $1,265. Using today’s prevailing 7.25% rate, that same mortgage requires a monthly payment of $2,045. That is a difference of almost $9,500 more per year!
This creates what economists call a “lock-in effect.” These homeowners are financially disincentivized to sell. Moving means securing a new mortgage, and with significantly higher rates, the monthly payment for a similar home could be much steeper. Why trade in a low monthly payment for a higher one, especially if you’re happy in your current home?
Not only is the lock-in effect real, but its magnitude paralyzes the housing market. According to the Federal Housing Finance Agency, a 3.2% gap exists between the average rate on an existing mortgage and the current rate on a new loan. To put that in context, between 1998 and 2020, there was never a time when more than 40% of existing mortgages were more than one percentage point below the current market. Now, however, almost 70% of existing mortgages are more than three percentage points lower than the current market.
So, what does this mean for the overall market?
Limited Inventory: With many homeowners staying put, the number of houses available for sale remains low. This lack of inventory is a major factor keeping prices high despite rising interest rates that might otherwise cool demand. Would-be buyers face a competitive market with fewer options, potentially leading to bidding wars and higher prices in some areas—a double whammy.
A Buyer’s Quandary: Prospective buyers are stuck between a rock and a hard place. Higher interest rates mean a larger monthly payment for the same house than a few years earlier. However, the limited inventory means they might have to act fast and potentially overpay for a home if they want to find something suitable.
A Silver Lining for New Construction: The limited resale market might be a boon for new construction. Builders are seeing increased interest, particularly for smaller, more affordable homes. This could add some much-needed inventory to the market in the long run.
Is There Hope for First-Time Buyers?: It can be discouraging for those looking to enter the market for the first time. However, there are still opportunities. Consider looking in less competitive areas, exploring alternative financing options by shopping different lenders for rates, or being patient and waiting for the right home to come along. Working with a qualified real estate agent experienced in navigating this unique market can be a tremendous asset.
What’s next?
Experts predict the situation will remain like this for some time. A significant drop in mortgage rates is unlikely in 2024, and many existing homeowners will likely hold onto their low rates for as long as possible. This could lead to a slower overall market with continued high prices until more new construction potentially eases the supply crunch.
The housing market in 2024 is a complex dance among low locked-in rates, rising current rates, and limited inventory. While it can be challenging, there are still opportunities for both buyers and sellers. Understanding the unique dynamics can help you make informed decisions as you navigate this ever-evolving market.
Jonathan Koop, is a Senior Portfolio Manager at Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. For more information, visit their website at www.BedelFinancial.com or email Jonathan at JKoop@BedelFinancial.com
