Making sense of the housing enigma: Why high mortgage rates aren’t cooling the market’s heat

Home mortgage rates continue to rise in the US, and by some measures, home affordability is at all-time lows. And yet, some statistics suggest the housing market is starting to thaw. 

New home sales are up in 2023, as are new single-family housing construction. Home prices have also started to rise in recent months. So, if homes are so hard to afford, how can it be that home prices are rising again? Here’s our take on where the housing market stands now, and what it means for you.

Resale market: still frozen

Earlier this year, we described the housing market as “frozen.” Since then, nothing has changed in the resale market. 

The chart below shows sales of existing homes. Today’s figure is lower than the depths of the COVID pandemic and was only materially lower in the aftermath of the Great Financial Crisis.

Source: National Association of Realtors

The problem is not demand for homes. As we’ll discuss in a moment, demand remains strong. 

The problem is a lack of homes listed for sale. The next chart shows the total number of homes listed for sale. To adjust for seasonality, we show the figure as of July each year---the most recent current month available.

Source: National Association of Realtors

The reason why so few houses are for sale is pretty simple: mortgage rates. According to Freddie Mac, the national average 30-year fixed mortgage rate is 7.12%, near a 25-year high. That means virtually every current homeowner has a lower mortgage rate than today’s rate. According to mortgage data provider Black Knight, the average rate on outstanding mortgage loans is 3.94%. 

To put that interest rate gap into perspective, say a homeowner with a 3.94% mortgage were to sell their house and buy a new one at the same price but now with a 7.12% rate. That would increase their monthly payment by 42%.

Simply put, most people can’t afford to sell their homes, so they aren’t.

Housing demographics indicate strong demand

Various indicators suggest that core housing demand should be high right now. The millennial generation, broadly speaking the group of Americans in their late 20s through late 30s, is now the age when people typically buy their first home. The most recent census showed that the 30-34 population grew by 5.9% over the prior five years vs. just 2.5% for all other age groups. 

Perhaps most directly, we can look at household formations. Essentially, this is a measure of the net number of people now supporting themselves or others living in the same home. 

According to Bloomberg, in the ten years ending in 2017, an average of 858,000 new households were created per year. Over the last year, that same figure was 1,835,000. In other words, more than twice as many people are looking for homes today than five years ago.

Putting all this together, more people are forming households, and those people need to live somewhere. That points to a high fundamental demand for housing despite high-interest rates, making it expensive to buy a home.

This demand is keeping home prices high

After falling for most of 2022, home prices are rising again.

Source: S&P Corelogic

This is something of a paradox. As we said previously, the National Association of Realtors home affordability measure indicates that homes are less affordable today than even during the 2000’s housing bubble. This measure compares the total cost of buying a typical home, including mortgage rates and the house price, to the median family income. 

One would think that if houses were so hard to afford, then prices should naturally decline. However, we are seeing that because the demographics for home buying are so strong and so few existing homeowners are selling their homes, the supply and demand dynamics are enough to keep home prices rising.

New home sales rebounding

The lack of sellers of existing houses is causing some changes in the new home construction market. After the 2008 housing bust, single-family home construction plunged and never recovered. The pace of home building from 2010-2020 was below that of 1990-2000.

Source: Census Bureau

When you read that there is a housing shortage in the US, the lack of new home construction is a major reason why. 

That being said, the chart indicates that new homes completed have risen 11% so far in 2023. This likely means that the lack of existing homes for sale is fueling demand in the new construction market. 

Notably, high mortgage rates are also changing the types of homes builders are constructing. The median price of a new home sold has declined 13% so far in 2023, which would represent the largest annual decline in this measure on record.

Some public statements from larger homebuilders suggest this is just the beginning of a trend. Pulte Homes CEO Ryan Marshall said in a recent earnings call that “first time home buyers are opting to go with less square footage or fewer options and upgrades.” 

Lennar Executive Chairman Scott Miller said that the company’s average sales price had declined, adding that consumers’ “pent-up demand continues to come to market and consume affordable offerings.” 

In an investor presentation, M/I Homes highlighted their “focus on affordability” and said that their first-time home buyer program made up 55% of sales in the second quarter.

Given the rapid pace of new household formation, any increase in housing supply, especially if that supply is focused on homes for potential first-time buyers, would certainly be welcomed. 

While construction has a long way to go to stem the current housing shortage, the trend is going in the right direction. Only new homes completed rose 11% in 2023, and new building permits have increased 24%. The trend needs to continue, but the signs are positive.

People buy what they can afford

It is certainly true that buying a home is a major financial decision, but the reality is that most people don’t buy a home based entirely on financial factors. People generally buy when it is the right time, based on life events like marriage or having children, not on macroeconomic factors like interest rates.

Today’s high mortgage rates are indeed impacting what kind of home people can afford, but it may not change people’s desire to purchase one. 

The shift in new home construction toward lower-priced homes supports this view. People choose to buy a home based on life events and then seek the best house they can afford from there. 

Unless interest rates fall substantially from here, the basic dynamics in the housing market will likely continue. Given strong core demand and a lack of existing home sellers, there’s no reason to expect home prices to decline significantly. Moreover, if mortgage rates were to fall modestly, it could be that home buyers jump at the chance to lock in lower rates, pushing home prices up all the more.

If you are considering buying a home, talk to your planner about every detail you need to know.