The path to 2019: How the trends of yesteryear influence today’s home prices.
Whether you’re buying a home, selling a home or just exploring your options, there are a lot of factors to consider regarding the climate of the market at the time.
Rising interest rates, falling home sales, and talk of a recession in 2019: what does it all mean? Why should you care? If you’re not an expert on the real estate or financial markets (or in possession of psychic abilities), we’ve got you covered. We’ll guide to a better understanding of today’s housing market trends, but first, let’s take a look back.
More interested in projected future trends? Jump over to Part 2.
We’re seeing one of the longest periods of economic growth in US history.
When the housing market crashed in 2008, it led to one of the worst economic periods since the Great Depression, often called the Great Recession. The economy has not just recovered from this period, but grown steadily each year since the crash.
Over a decade after the Great Recession, unemployment is the lowest it’s been in 50 years, wages are rising at a faster rate, and consumers continue to spend more, which fuels the economy.
Think of these trends as pillars that support economic growth: the more people who have jobs, higher wages, and money to spend, the stronger the foundation of the economy.
As the economy grew, home prices rose rapidly across the country.
Since 2012, the number of eager home buyers increased faster than the number of homes for sale–demand rose faster than supply. Let’s look at some of the reasons why:
In the last few years especially, the low unemployment rate combined with low costs of financing a home meant more people could afford a home; demand increased.
At the same time, the number of homes for sale reached the lowest in decades, in part because fewer homes were being built and because many homeowners had financial incentives not to sell; supply stayed low.
“Home prices increased as more buyers competed for fewer homes.”
What happens when more people want to buy homes than there are homes for sale? Home prices increased as more buyers competed for fewer homes.
The Fed increased rates to prevent the economy from growing too fast.
As the economy recovered from the Great Recession, prices for goods and services began to rise, known as inflation. This is normal, but if inflation happens too fast, it can spiral out of control.
One of the ways the Fed can control inflation is by adjusting the federal funds rate. If you’ve heard about “rising rates” in the news; this is what those headlines are referring to. Rising interest rates impact the ability to afford a home.
The Fed: Everything you need to know
What is the Fed?
The “Fed”, short for Federal Reserve, is like our nation’s bank for banks, but it’s also kind of like a pilot for the economy. It’s job is to maximize employment and stabilize prices, all with the goal of keeping the economy growing at a steady pace. One of the ways it can control inflation is by raising or lowering the federal funds rate.
What is the federal funds rate and why does it matter?
The federal funds rate is the interest rate that banks use to lend money to each other, and that cost gets passed to consumers when they pay interest on a loan. The Fed doesn’t set “the interest rate you pay”, it influences the price for banks to loan money to you. When the fed funds rate goes up, it causes short-term interest rates, like what you pay on a credit card, to increase. People then spend less and save more which slows inflation.
Why does the Fed raise or lower the federal funds rate?
Typically, when the Fed is less confident about the health of the economy, rates go down. It then becomes cheaper for banks to loan money so people borrow more and spend more. In 2008, the Fed slashed rates to virtually zero. When the Fed is confident about the health of the economy, it tends to raise rates to slow inflation. Following strong job growth in 2018, the Fed increased rates each quarter.
How does the federal funds rate impact long-term interest rates like a mortgage?
The federal funds rate does not directly impact long-term interest rates like a 30-year, fixed rate mortgage. Just because the fed funds rate increases, does not mean the cost of a mortgage will do the same. Long-term rates are influenced by Department of the Treasury yields, investor sentiment, and inflation rates, among many other factors. Learn more in our blog on interest rates and home ownership.
“The fed funds rate does not directly impact long-term rates. Just because it increases, doesn’t mean mortgage rates will do the same.”
The Fed is focused on the bigger picture of stabilizing prices and maximizing employment; it doesn’t favor one segment of the economy over another. It wouldn’t say “Oh no, oil prices are rising; let’s bring those down.”
It would say, “Prices for all goods and services are rising too fast; let’s raise the fed funds rate to slow inflation.” As a natural consequence, buying a home could then become less affordable. This scenario is similar to what’s happening today.
Rising rates have made homes less affordable.
Why care about interest rates? Both short-term interest rates (like what you pay on a credit card) and long-term interest rates (like what you pay on a mortgage) influence your ability to afford a home, but in different ways:
Short-term interest rates impact your budget.
If you deposit money in a savings account, a rise in short-term rates does increase the interest on your savings. However, savings rates tend to be much lower than the interest you pay on short-term debt, roughly 1% vs 15% respectively. If you’re paying higher interest on your credit card, then you have less room in your budget to spend on the things you want like new clothes, a new car, or a house.
Over the past few years, the Fed has steadily increased short-term interest rates, which can lead people to have a tighter budget for a home at a time when home prices are rising.
Long-term interest rates impact your mortgage payment.
Over the past five years, the average cost of a 30-year, fixed rate mortgage has fluctuated between 3.5–5.0%. In 2018, it rose from 4.0–5.0%. Let’s look at how that impacts your monthly payment for a $200,000 home:
Purchase price: $200,000
Monthly payment (4% interest rate): $961
Monthly payment (5% interest rate): $1,056
$ Increase: $95
% Increase: 9.8%
A 1% increase in the mortgage rate means you’d pay about 10% more per month.
Source: Opendoor mortgage calculator; Assumes 20% down; $66 for insurance; and $132 for property tax.
“Today, the combination of rising interest rates and rising home prices has outgrown what many Americans can afford.”
So how expensive are homes? We can measure housing affordability on a scale from 0 (most affordable) to 10 (least affordable).
As homes became less affordable, fewer people bought homes in 2018. But home prices are still on the rise.
When fewer people can afford homes, fewer people buy homes. The number of new homes sold in 2018 declined roughly ten percent compared to 2017, the steepest decline in seven years.
There’s no need to panic; home prices still rose across the country, just at a slower pace than they did the year before. 2017 saw record increases in home sales and home prices.
“We’re seeing slower growth following the highest growth we’ve seen since 2008.”
Let’s recap all of the trends that have brought us to where we are today:
Because we’re so used to seeing home prices rise rapidly, it’s easy to forget that the pillars of the economy are strong. Recently, there’s been a lot of speculation about a looming recession or a major crash like in 2008.
The economy and housing market look much different today than the period leading up to the Great Recession–slower growth doesn’t mean history will repeat itself.
Feeling comfortable with the historical trends in economic growth, interest rates, and affordability? Great! Ready to learn what lies ahead for the housing market? Check out the rest of our macro report on housing trends here.
