How Will Higher Interest Rates Affect the Housing Market?

How Will Higher Interest Rates Affect the Housing Market?

Roger Pettingell Sarasota Real Estate

The housing market has become a key focal point for many investors. Indeed, housing makes up a significant percentage of the CPI readings everyone is watching closely. Accordingly, the expectation is that higher interest rates could help calm inflation, at least on the housing portion of this key metric.

This week, the Federal Reserve continued hiking rates at its fastest pace in decades. The FOMC announced another 75-basis-point (0.75%) hike to the Federal Funds rate. This move, which impacts the short end of the yield curve, has already bled through to many variable-rate lending products.

However, mortgage products are a little bit different. Let’s dive into whether this rate hike will have the anticipated effect on mortgages the Fed is hoping.

Can Higher Interest Rates Cool the Housing Market?

Interestingly, the mortgage market is (at least right now) acting in a somewhat detached way from the Fed hiking schedule. The Federal Funds rate has increased 1.5% over the past six weeks, following two sequential 75-basis-point moves.

However, after the average 30-year fixed mortgage hit a rate of 5.78% on June 16, following the first of these two sequential rate hikes, mortgage rates are actually down. That’s right, the average 30-year fixed mortgage has sunk to 5.3%, meaning homeowners are actually able to lock in better rates, despite the overnight interest rate skyrocketing.

So, what gives?

Well, mortgage rates are derived from bond yields. However, it’s not the short end of the curve that matters. Rather, it’s typically the 10-year and 30-year bond rates that matter more for longer-dated debt. That’s because lenders typically borrow short (short long-term bonds) and lend out the proceeds via a mortgage. The lender pays the yield on the long bonds, and pockets the difference in risk premium.

10- and 3o-year bonds actually look much more attractive right now, relative to shorter-duration bonds. That’s because many investors are pricing in a Fed hiking cycle at some point. Thus, indications are that, longer-term, near-zero rates are here to stay.

Now, those with variable-rate mortgages, or ARMs (adjustable rate mortgages), will feel the immediate impact of these moves. However, for the vast majority of homeowners with fixed-rate, long-duration mortgages, it’s unclear whether these higher rates will cool inflation to the degree the Fed wants. Until longer bond yields trade higher, the jury remains out.

On the date of publication, Chris MacDonald did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the Publishing Guidelines.

Chris MacDonald’s love for investing led him to pursue an MBA in Finance and take on a number of management roles in corporate finance and venture capital over the past 15 years. His experience as a financial analyst in the past, coupled with his fervor for finding undervalued growth opportunities, contribute to his conservative, long-term investing perspective.

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