Editor's note: This story was originally featured in the November issue of DS News, out now.
As the Chief Economist for First American Financial Corporation, Mark Fleming leads an economics team responsible for analysis, commentary, and forecasting trends in the real estate and mortgage markets. As a trusted and influential voice with 20-years’ experience in the mortgage and property information business, Fleming is frequently quoted by national media outlets. For weekly analysis and research, follow him on Twitter at @mflemingecon.
We’ve been spoiled with historically low mortgage interest rates. Where do you predict they will go?
Not only have we recently enjoyed historically low rates, but also a general, long-run decline in rates since 1981. So, a generation of homebuyers has benefited from increased home-purchasing power over time.
As for the future, improving economic conditions and the recent announcement by the Federal Open Market Committee (FOMC) that it will reduce the portfolio of bonds and mortgage-backed securities that it purchased under its quantitative easing policy are strong signals that rates will rise modestly over the coming year.
In fact, mortgage rates increased in the week following the FOMC announcement of “quantitative uneasing.” Even if rates rose by another 2 percent to approximately 6 percent by the end of 2018, which is highly unlikely, rates would still only be where they were in 2008—a level that homebuyers had not seen since the mid-1960s. To use a technical economic term, rates that low still offer consumers historically pretty darn good home-purchasing power.
What does this mean? How could it affect homebuyers, and in particular, first-time homebuyers?
It is important to point out that if you are among the nearly two-thirds of U.S. households that already own homes, rate increases mean, really, nothing! That’s because the vast majority of existing homeowners either own their homes without a mortgage, or have a 30-year fixed-rate mortgage.
Therefore, an increase in the mortgage rate will have no impact on the majority of existing owners. If you are contemplating buying a home, then things are a little less affordable than before. But, let’s be clear. It is true that purchasing power is lost and affordability declines as mortgage rates rise.
However, given our expectation for an orderly and modest increase in rates over time, I think the most appropriate characterization of the market is homes are becoming less affordable but are not yet unaffordable by any reasonable historic standard.
At what point would rising mortgage rates start to significantly dampen buyer demand?
We actually surveyed real estate professionals this past spring and asked them what the mortgage rate would need to be before it would have a significant impact on homebuyer demand. The answer—more than 5 percent. Most forecasts don’t expect mortgage rates to reach that level until 2019.
How will mortgage rates influence inventory?
That’s a good question! Most of the inventory of homes for sale is supplied by existing homeowners who mostly have existing mortgages. So, for existing homeowners, there is either a financial benefit or cost to selling their home and presumably becoming a homebuyer that depends on whether the mortgage rate on their existing mortgage when they sell their home is higher or lower than the mortgage rate on the home that is ultimately purchased.
As mortgage rates have typically been declining since 1981, this dynamic has almost always been a financial benefit to existing homeowners—the mortgage rate on the home purchased is lower than the mortgage rate on the home that was sold.
In a rising rate environment, the mortgage rate on the home purchased is higher than the mortgage rate on the home sold, which adds cost. The more rates rise and the larger one’s loan, the more costs increase. The rate locked-in cost will grow as rates rise and may prevent existing homeowners from listing their home and adding to the inventory of homes for sale.
Housing inventory, or lack thereof, has been continuous in the housing market. What do you foresee in the next year for the inventory narrative?
As I have described, the rate locked-in effect will only grow as rates rise, but what is more immediately pressing is the fear of not finding something to buy.
According to our survey of real estate professionals this summer in our Real Estate Sentiment Index, we found that real estate professionals operating in short-supplied markets believe the main reason for a lack of supply is existing homeowners are not listing their homes for sale because they are worried that they will not be able to find something to buy.
Existing homeowners face the dilemma of wanting to sell, but fear not finding something to buy. Add the increased cost from a growing-rate locked-in effect, and it’s fair to ask, “Are homeowners becoming prisoners in their own homes?”
What else should those following the housing market look out for in the next year? Any wild cards?
I see a pretty clear narrative for next year that really seems to be an extension of this year. Modestly rising rates, tight inventory in most markets, and, therefore, strong house-price appreciation.
The wild cards I believe would be from the macroeconomic or geopolitical stage. What often happens in other countries and financial markets can influence our mortgage rate outlook, and not always negatively.
Who would ever have thought that Brexit would benefit the U.S. housing markets with a mortgage-rate deduction? Yet, that’s what happened. If the housing market outlook changes, my guess is that it will be because of something shocking our economy or financial markets.