While low mortgage rates boost consumer buying power, the reason for the low rates could hold home buyers back.
Economic forecasters and analysts have frequently missed the mark recently when forecasting interest rates. In general, forecasters and experts have expected faster economic growth and policy normalization (i.e. higher interest rates) than has come to pass. Instead, interest rates, including mortgage rates, have remained low and moved lower. Today’s mortgage rate data from Freddie Mac show that the rate on a 30-year fixed-rate mortgage was 3.41—the lowest since May 2, 2013 when rates were 3.35 percent.
While lower mortgage rates are a good thing for U.S. home buyers, 86 percent of whom financed their recent purchase transaction, the reason for lower mortgage rates might offset some of the positive effects. Uncertainty over Brexit is highlighted as a reason, and while it has certainly had an impact, the cause of low rates is concern that global economies are not growing. Note, for example, that much of the decline in mortgage rates occurred during the first quarter of 2016—before the Brexit vote in June, which only added more uncertainty about growth prospects and took rates on another leg down. A look at the pros and cons of this recent drop in mortgage rates shows that they may not be as unambiguously beneficial to the housing market as previous low rates have been.
Lower mortgage rates—which have declined by more than 50 basis points since the start of the year—boost the home purchasing power of would-be buyers.
Here are some calculations:
- A 50 basis point reduction in mortgage rates reduces monthly payments by nearly $50 per $100,000 in home price ($80,000 financed).
- The reduction in monthly payments reduces income needed to qualify by roughly $1,000.
- At the current US median home price, this amounts to a roughly $2,500 reduction in the income required to finance a home purchase with a 20 percent down payment ($200,000 mortgage).
Coupled with incomes that are maintaining a steady pace of increase between 2 and 3 percent over the last two years, the reduction in mortgage rates will help sustain housing market demand in the face of rising home prices.
While lower mortgage rates could boost demand, global economic growth concerns could shake U.S. consumer psyche, especially if U.S. workers expect slowing global growth to impact labor markets. On top of this concern, potential home buyers are experiencing difficulty finding a property amid inventory shortages and saving for a down payment, particularly if they are potential first-time home buyers managing student loan debt and increasing rental prices. In fact, 71 percent of student loan borrowers who are non-homeowners indicate that student debt is impacting their ability to purchase a home.This could mean that the benefits of lower mortgage rates go largely to current homeowners who can refinance, reinforcing the already sizable gap in wealth outcomes for those who own their homes compared to those who do not.
Thus far, the U.S. economy has proven resilient to the weaker global economic environment. A stronger U.S. consumer, who benefits from lower financing costs, may help ensure that trend continues.