Are the Hottest Days of the Housing Market Behind Us?

It won’t all happen yesterday or today, but this unprecedented hot seller’s market is finally starting to cool. The combination of rising home prices and rising mortgage rates is putting a damper on buyer demand. Not because the demand itself is going away but because more and more buyers are becoming priced out of the housing market. Still, that doesn’t mean a crash is going to happen.

Freddie Mac says that house prices rose 5% for the first quarter of this year and the National Association of Realtors (NAR) says prices on closed sales are up 6%. On March 16, the Fed raised the interest rate for the first time since 2018. By mid-April, 30-year mortgage rates had risen above 5% for the first time since 2011 (more than a decade). The NAR says median home sales prices have gone up 41% from the first quarter of 2020 to the first quarter of 2022. Those are the key facts describing this hot housing market.

It’s Not Only First Time Buyers Being Priced Out of the Market

Certainly, first-time buyers have been the hardest hit during this market surge. People with low-down payments of about 3.5% could afford a $225,000 mortgage at 2.8%. But there wasn’t much to buy, which resulted in bidding wars that did do one thing. It allowed sellers that were ready to move up in the market to sell their starter homes for record profits and pay recorded prices for the homes they were moving up to.

These second and third-time buyers are the ones that contractors chose to build for because they could make more profit. Contractors build $400,000 and $500,000 homes that repeat buyers could afford with the $100,000 profit from their first home and a 3% mortgage.

After bidding wars and a lack of starter home construction, the severe shortage of entry-level homes still exists. Now the next tier up is becoming unaffordable to existing homeowners.

Mortgage Cost Increases Over 10 years

A second-time buyer who took out a $400,000 mortgage at 5.1% interest rate for a $500,000 house in April would have a $2,171 mortgage (before taxes and insurance). That is about $5,500 (or 27%) more per year than it was last year. If house price increases are only about 6% this year, that $500,000 house will soon cost $530,000. At a 6.2% interest rate, the monthly P&I will jump to $2,570.

The NAR reported that the median home price was $154,700, ten-years ago, in January of 2012. At that time, mortgage rates were averaging 3.7%. With a 5% down payment of $7,740, the monthly P&I would be $675.

According to the latest data from the U.S. Bureau of Labor Statistics average wages are $53,490 in 2022 compared to $40,300 in 2012 ($54,569 in 2020 dollars). In general, purchasing power has stayed flat. Yet, the cost of a mortgage to buy a bigger and better home has increased from $675 to $2,570 ($1,895 per month increase). Some people have done very well financially over the past 10 years that will buy these extraordinarily expensive homes. There will be many more that cannot come anywhere close to affording these homes and will remain in their starter homes.

The Housing Shortage Will Persist

The short-term future for starter homes looks bleak. It’s estimated that the U.S. market has a shortage of between 4 and 6 million homes. Contractors are still faced with both high costs and raw material shortages. Those same rising costs exist whether contractors build starter homes or upper-tier homes. Homeowners with 3% fixed-rate mortgages or have refinanced to 2.5% 15-year fixed-rate mortgages are going to stay put. Nothing is happening to relieve the housing shortage.

A price bust in the housing market is highly unlikely because there is strong demand at multiple levels. People will buy houses if they can afford them. However, even if the double-digit price increases become more reasonable at about 5% or 7%, the swift increase in mortgage rates has become the next factor keeping the housing market tied in knots for the foreseeable future.

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