Home News Speedy escape from housing market slump unlikely: ARMs tied amid low rate lock-up

Speedy escape from housing market slump unlikely: ARMs tied amid low rate lock-up

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Home sales, construction volumes, and even home prices in many markets now (the last shoe to fall in the housing adjustment) are all falling. Clearly, mortgage rates are down from 2.6% in December 2020 to September. The fact that it jumped to 6% in the early days is handcuffing many homebuyers.

Mortgage rates fell to just 5% in the fall of 2018, a short period of two months when demand for housing contracted sharply. Affordability has improved as mortgage rates have dropped to 4.5% for him by December 2018.

Now, with mortgage rates above 5% for the sixth month in a row, the housing market is struggling to find a bottom.

5% mortgage rate threshold

Why focus on 5% mortgage rates as a trigger for homebuyer fatigue? Low mortgage rates in 2020-21 were key to mortgage escape speed has now locked in homeowners who bought or refinanced their homes during this once-in-a-generation financing period.

consider it 85% of outstanding mortgages are pegged at interest rates below 5%, 24% remain at an attractively low level of less than 3%. Good luck convincing someone to give up a fixed-rate mortgage under 3% or even 4% when inflation is at his 40-year high and the cost of everything is highly variable.

In fact, according to a recent survey, New Home Trend Institute64% of homeowners with a mortgage I will never buy a mortgage if the interest rate is above 5%The unwillingness to repurchase existing homeowners whose mortgage interest rate is 6% or higher jumps to 85%.Existing Homeowner Account 51% of all home purchases require a mortgage According to the National Association of Realtors, any disruption to their homebuying activity will have a significant impact on the overall housing transaction.

Knowing that existing homeowners make up 51% of all home purchases and 64% of them are reluctant to buy again at a mortgage rate of 5% or higher, 33% of home transactions is likely to disappear rapidly in the near future. The staggering 43% of home purchases could disappear when mortgage rates rise above 6%. These percentages are staggering and may reflect the backdrop of today’s terrible selling prices, which continues to be the worst in history.

Don’t count on variable rate mortgages (ARMs) to offset affordability pressure

In addition to the low-interest-rate lock-in effect of deterring homebuying activity for existing homeowners, stricter underwriting guidelines for post-Dodd-Frank variable-rate mortgages (ARMs) have increased the potential for all homebuyers. Home purchases may decline.

Before the Great Financial Crisis, homebuyers qualified for ARM’s low introductory teaser rates, but after Dodd Frank Buyers typically need to qualify for higher reset rates to avoid payment shock. At a glance, ARMs accounted for 17% of all mortgage originations from 1990 to 2008 and have acted as a valve to release affordability pressure in every past rate spike cycle.

When interest rates on 30-year fixed mortgages topped 9% in the mid-1990s, ARM usage jumped to 35% of all mortgages. In 1999-2000, when interest rates on 30-year fixed mortgages rose above 8%, ARM usage rose again to 34% of all mortgages.For comparison, the percentage of homebuyers Only 8.5% currently use ARM.housing affordability is near an all-time low, with 30-year fixed-rate mortgages more than doubling in 19 months.

Furthermore, the interest rate spread between 30-year fixed rate and variable rate mortgages is widest since 2014, indicating a lower than normal ARM rate relative to the fixed rate. Though cautious in the long run, post-Dodd-Frank ARM’s underwriting guidelines have proven painful for housing in its first extended dance as interest rates rise.

Falling house prices help reset affordability

We expect falling home prices in many markets, combined with rising incomes, to improve affordability in the future. This process should help encourage existing owners to buy again going forward, even if interest rates don’t return to their historic lows in 2020-2021. Only time will tell how long and deep this reconditioning process will take before the home finds its floor.

From our perspective, the affordable medicine many housing markets need is double-digit price declines, especially in the new home market. For reference, the principal and interest payments for a $400,000 mortgage with a 3.5% mortgage rate are about $1,800 per month. If the mortgage rate is 5%, then reducing the price of the same house by 16% will result in the same mortgage payment of ~$1,800. Markdowns are a powerful way to achieve affordability.

A tsunami of supply is unlikely, but don’t ignore the coin’s demand side

Absent unemployment and a sharp drop in income, homeowners pegged on old fixed-rate mortgages in 2020-21 are unlikely to be forced to sell their homes. The same goes for the majority of homeowners avoiding the potential buzzsaw of resetting the ARM.

Together, these two forces should limit the wave of housing supply to hit the market. This is good. But it remains to be seen whether these same forces will constrain and handcuff demand in ways housing has not faced in past rising interest rate environments.

Judging by the accelerating pace of softening across home sales, construction volumes and current prices, housing doesn’t seem to have the key to getting out of this downturn anytime soon.

Rick Palacios Jr. is Research Director and Managing Principal at John Burns Real Estate Consulting.

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