Rising rates will cool, not crash, the housing market - Capital Economics
US Housing

Rising rates will cool, not crash, the housing market

US Housing Market Update
Written by Matthew Pointon
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We now expect mortgage interest rates will rise to 4.0% by the end of the year, and to 4.25% by end-2022. But housing demand will be supported by a reopening economy, the large fiscal stimulus, frustrated buyers still looking for homes and substantial savings built up during the lockdowns. Banks are also likely to ease lending standards, offsetting some of the hit to purchasing power. The jump in rates will therefore just help cool, rather than crash, the housing market.

  • We now expect mortgage interest rates will rise to 4.0% by the end of the year, and to 4.25% by end-2022. But housing demand will be supported by a reopening economy, the large fiscal stimulus, frustrated buyers still looking for homes and substantial savings built up during the lockdowns. Banks are also likely to ease lending standards, offsetting some of the hit to purchasing power. The jump in rates will therefore just help cool, rather than crash, the housing market.
  • The rise in yields in response to this year’s shift in fiscal policy and the Fed’s willingness to accept higher long-term interest rates means we now expect the 10-year yield will end 2021 at 2.25% and 2022 at 2.50%. (See Update.) That implies a rise in the 30-year mortgage rate to 4.0% and 4.25% over the same period.
  • Higher mortgage interest rates will certainly weigh on both sales and prices, but we doubt the rise we are forecasting will trigger a crash in activity or prices. Mortgage rates are just one of the factors that drive the housing market and, looking beyond interest rates, the underlying environment for home demand over the next couple of years is still favourable.
  • The reopening of the economy, coupled with a substantial fiscal stimulus, will boost incomes. Moreover, a year of lockdowns has led to a surge in savings. Between the end of 2019 and Q3 2020 cash savings increased by $2.2tn, and some of that is already being used to bolster down payments. Finally, a record low number of homes for sale means that many households that wanted to buy over the past year will not have been able to. Most of those frustrated buyers will still want to buy even at a higher mortgage rate.
  • Overall, we expect total home sales will end the year at around 6.53m annualised. That’s 16% lower compared to the unsustainably high number of sales seen in Q4 2020, but 6% higher than their pre-COVID level of 6.19m in Q1 2020. (See Chart 1.)
  • However, future buyers will find they have less to spend on a home. With a constant debt-to-income ratio, an increase in mortgage rates from 3.0% to 4.25% means the maximum mortgage size will drop by 14%. But that will not translate directly into lower house prices. The strengthening economy and high levels of home equity mean banks are likely to respond by easing lending standards and accepting higher DTIs. Indeed, that is what happened in 2018, when rising mortgage interest rates only led to a small fall in average home purchase mortgage size. (see Chart 2.)
  • That said, we doubt any loosening in standards or higher down payments will be enough to entirely offset the impact of higher interest rates, and mortgage size will flatten out. As a result, we anticipate a substantial slowdown in house price growth from 10% at the end of last year to around 3% y/y by end-2021.

Chart 1: Total Home Sales & 30-Yr Mortgage Rate

Chart 2: 30-Yr Mtge Rate & Purchase Mtge Size

Sources: Refinitiv, MBA, Census Bureau, Capital Economics

Sources: Refinitiv, MBA, Capital Economics


Matthew Pointon, Senior Property Economist, matthew.pointon@capitaleconomics.com