Can A Depleted Housing Supply Offset Rising Rates?

Can A Depleted Housing Supply Offset Rising Rates?


The Federal Reserve has been threatening for quite some time to raise interest rates, which would in turn causes mortgages rates to rise as well. Conventional wisdom says that a rate hike will rein in the demand for homes and their prices, but a shortage on the supply side could outweigh everything.

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How Low Interest Rates Have Affected Mortgage Rates?

The interest rate for U.S. securities (a 10-year treasury bill, for example) is often used as the benchmark for determining other rates. Interest rates, therefore, tend to be positively correlated, and mortgage rates are no different. When the Federal Reserve cut interest rates to nearly 0% in response to the financial crisis, mortgage rates subsequently fell as well. As a result, the price of a 30-year fixed rate mortgage bottomed out at 3.35% in 2012 after it was more than 6% when the financial crisis first started.

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As the Fed continues to talk about the possibility of raising its rates, one thing seems all but certain for mortgage interest rates: they’re about to rise as well. This should, in theory, cool the demand for housing because the cost of housing this getting higher. When interest rates are low, potential buyers have an incentive to purchase a home because they can use cheap debt to finance their house. If enough people think this way, prices as a whole should rise because there is a lot of activity and competition in the market. When rates rise, however, it becomes more expensive to finance a home and the thought of buying a house does not look as enticing. That, however, might not be the case this time around.

 Low Supply Might Outweigh the Shift in Demand.

The housing supply is low right now for a number of reasons. One is that there is a greater demand for housing in more urban communities that are closer to larger cities, and there is much less room for development in cities than in the suburbs. Supply, therefore, is extraordinarily limited. The second reason is that the number of new homes cannot keep up with population and demand growth. Some argue that manufactures will have to spend more on labor to keep up with demand, and those costs will be passed along to consumers (the home-buyers), which will drive prices up even further. Lastly, housing supply is also low because the government has taken increased measures to protect the environment, making it more difficult for contracts to build near certain bodies of water.

There are now two factors working against each other: higher interest rates and low supply. Higher interest rates should lower demand, which in turn lowers prices. On the other hand, limited supply should raise prices. It is unlikely these two events offset each other, and conventional wisdom right now is that the supply side of the housing market is too small to be affected by a modest increase in interest rates.

The Housing Market After The Financial Crisis.

In 2006, there was a slow decline in the housing market, and in 2012, it hit an all-time low. The S&P/Case-Shiller 20-City Composite Home Price Index fell more than 35% during that time. Many homeowners were unable to pay their mortgages, and lenders were unable to help individuals with refinancing because they were running out of funds.

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Today, however, the housing market appears to be finally bouncing back from the financial crisis. Sales are up by almost 50%, and many changes have been made to how buyers can more safely and simply buy a home. Mortgages have been refinanced and many individuals were able to benefit from modified loans that let them avoid foreclosure.

What Experts Are Saying About The Results?

This low supply of homes being built is having a direct effect on the price, which is ultimately leaving everything in a vicious circle. The low supply of houses available is driving up the demand and increasing the prices, which in turn is making current homeowners wait until they decide to sale their home to upgrade to another. If the supply of homes would increase according to most experts, the prices of purchasing a home will begin to even out, but with the current lack of supply, prices will just continue to rise. Lawren Yun, the chief economist for the National Assocation of Realtors, is quoted by CNBC as saying: “If we can get additional increase in supply, then price increases will begin to flatten out, which will be good for the economy (and) good for many first time buyers. But as long as we have limited supply, and that’s what we have today, then prices inevitably will continue to rise.”

 

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