The Federal Reserve is expected to raise interest rates in September. When this happens, I expect the U.S. housing market to become one of its first and biggest victims.
You must remember that the housing market and interest rates have a negative relationship. If interest rates rise, home prices suffer. This is basic economics.
The Impact of the Federal Reserve Interest Rate Hike
Interest rates haven’t even gone up, yet there’s already worry in the housing market.
Consider this; the Market Composite Index compiled by the Mortgage Bankers Association, a measure of mortgage loan application volume, decreased 3.5% on a seasonally adjusted basis for the week ended May 13, 2015 from the previous week. The Refinance Index decreased six percent in the same period. The seasonally adjusted Purchase Index decreased 0.2%. (Source: Mortgage Bankers Association, May 13, 2015.)
With this in mind, in their March economic projection, the Federal Reserve said they expect the federal funds rate to be around 0.625% and 1.625% in 2015 and 2016, respectively, up from its current 0.25%. Though these interest rates may not sound so high, from the current low level, this move will be substantial. (Source: Board of Governor Members of the Federal Reserve System, last accessed, May 14, 2015.)
Now with the interest rate at 0.25%, a 30-year mortgage rate in the U.S. stands at 3.75%. Imagine when the Federal Reserve raises the rate to 0.625% this year. It would be roughly a 150% increase from current levels. If they are moved higher again in 2016 to 1.625%, this will be a 550% increase from the current levels. (Source: Bank of America, last accessed May 14, 2015.)
With that said, mortgage rates will see similar hikes since they are tied to the federal funds rate. As a result, it shouldn’t be surprising to see home prices decline. Moreover, higher mortgage rates will make homes significantly less affordable for Americans. And those who want to sell will have trouble doing so.
Another Problem Haunting the U.S. Housing Market
To examine the demand, one must look at the number of first-time home buyers in the housing market, as they are a substantial force in driving home prices higher. Unfortunately, their numbers are very low at the moment.
For instance; in March, first-time home buyers made up 30% of all sales of already built homes in the U.S. (referred to as existing home sales). This was unchanged from the same period a year ago. In a normal market, on average, first-time home buyers amount to 40% of existing home sales. (Source: National Association of Realtors, April 22, 2015.)
In addition to this, those who would like to own a home are struggling. Over the past few years, thanks to low interest rates, home prices have increased. As a result of this, rental fees have gone up as well. These buyers are now using their income to pay for higher rent. This phenomenon makes a huge impact on their saving for a down payment.
Housing Market Outlook for 2015
If potential buyers are already struggling and the Federal Reserve has intended to raise the federal funds rate, it would be foolish to believe the housing market will be fine. I expect rough times ahead.