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The Truth About 5 Percent Mortgage Rates that No One Wants to Hear

5 percent mortgage rates are being painted as a nightmare for homebuyers, but they may be the best route back to a more balanced housing market.

April 21, 2022
April 21, 2022
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In the deep, timeless words of country star Luke Bryan: “Rain makes corn; corn makes whiskey; whiskey makes my baby girl get a little frisky.”

Like rain, mortgage rates in the 5's may feel like a drag as they eat away at housing affordability, but they’re also likely leading to better things, such as a healthier housing market in the coming months and years.

So here is the truth no one wants to hear: Sustained mortgage rates in the 5’s are exactly what the housing market needs right now to create balance and give homebuyers more time and options.

Let’s look at a few reasons why.

Sub-3.5% were unsustainable

In the housing market multiverse, there are countless paths the market can take. The current reality of 5% mortgage rates may seem like a nightmare to some homebuyers… until you imagine a market with mortgage rates remaining in the low-3’s, where they hovered for much of the pandemic.

Record low rates were effective in lowering mortgage payments, bringing more homebuyers into the market, and staving off a severe COVID recession. They also all but decimated the housing supply and sent home prices skyrocketing.

Just take a look at how inventory and home prices reacted to the average 30-year fixed mortgage rate dipping below 3.5%.

With rates below 3.5% from April 2020 to January 2022:

  • Home prices increased 31%
  • Active listings decreased 61%
  • Bidding wars more than doubled from 32.7% to 68%
  • Inflation increased to its highest rate in 40 years

Ultra-low mortgage rates may have been great for homebuyers that locked them in, but they were terrible for the health of the housing market and a key driver of the inflation we’re seeing today. And let’s remember that mortgage rates didn’t fall below 3.5% organically – it was a byproduct of a (hopefully) once-in-a-lifetime pandemic that, at one point, disrupted nearly every aspect of daily life.

Rates in the 4’s won’t slow price growth

Maintaining rates below 3.5% is a recipe for disaster, but what about all of that juicy middle ground between 3.5% and 5%?

Well, if the goal is to really slow price growth to a crawl, rates below 4.5% aren't the answer. They haven’t been able to do that in the last 12 years. Since 2010, the only two periods of substantially slower price growth occurred when the average 30-year mortgage rate was above 4.5%.

From 2011-2018, with rates consistently below 4.5%, homes appreciated on average 5% per year. That’s on the higher end of healthy growth and preferable to the near 20% growth we’re seeing in early 2022. But curbing price growth is a much heavier lift now than it was in the previous decade.

Not only is inventory at record lows, robust demand is all but guaranteed by a massive wave of millennials aging into their prime homebuying years during a time of strong job and wage growth. That’s not to mention the rise of remote work and homeschooling increasing mobility and fueling the desire for more space, and the sudden interest in single-family home rentals from investors as a hedge against inflation.

In other words, today’s housing market is a much bigger ship that requires more force to turn. Rates in the high 4’s may have had the oomph to slow the market in the 2010’s, but it’s unlikely they do now.

Rates could be higher

Now, it seems hard to imagine since we are currently witnessing one of the steepest rate increases in history, but there’s a universe in which mortgage rates would be higher and rising even faster than they are currently.

The primary driver of rising mortgage rates is market reactions to inflation-combating measures by the Federal Reserve. And in an effort to avoid shocking the market, the Fed has been foreshadowing these policies months in advance for nearly a year.

Had the Fed taken faster, more drastic action (which many people called for) the market reaction would likely have been more severe, and so would the rise in mortgage rates.

For example, rate increases would be even steeper if the Federal Reserve had chosen to raise the federal funds rate by 0.5% instead of the minimum increase of 0.25% in March. The Fed could also have tapered its asset purchases faster and with less warning.

More extreme policies by the Fed almost certainly would have meant higher mortgage rates today and faster cooling in the housing market, but they also posed the risk of sending the economy into recession. And then we’d have bigger problems than 5% mortgage rates.

Look at the big picture

Mortgage rates in the 5’s may seem astronomical after nearly three years of rates in the 3’s, especially to first-time homebuyers that have known nothing else.

However, ask any homeowner over the age of 50 and they will happily tell you that the mortgage rate on their first home was 6, 7, or 8 percent. In fact, catch a boomer on the right day and they will tell you about how they were lucky to lock-in a rate below 10% in the late 80’s.

Any time before 2008, a mortgage rate in the 5’s was almost unheard of because of how low it was. Imagine what it would take to slow an overheated market with 5% as a rock bottom rate.

Consider the worst case scenario

If the end goal is a balanced housing market with ample inventory and homes that appreciate more-or-less in step with wage growth, then 5% rates are not a half-bad way to get there.

Especially if you consider the alternative that more and more people are calling for (even if they are crying wolf).

The other means of slowing, halting, and or reversing price growth is a market crash – and nobody wants that.

Today’s market – overheated as it may be – is built on the solid fundamentals of low supply, high demand, and strong employment. Lenders have much tighter standards than the mid-2000’s and current borrowers are much more qualified to make their mortgage payments.

With that in mind, the road to a housing market crash most likely goes through a major disruption in employment. Whatever the disruption, it would have to result in millions of homeowners losing their jobs, defaulting on the mortgages, and flooding the market with foreclosed homes.

Given the housing market just survived a pandemic that wiped out more than 20 million jobs in a matter of two months, it would probably have to be worse than that.

So go ahead: Boo, hiss, throw tomatoes. The truth is, mortgage rates in the 5’s sustained over time are the least painful path back to a healthy, balanced market where homebuyers have options and some bargaining power at the closing table.

Mortgage rate projections are not a reflection of Fairway’s opinion or guarantee of interest rates in the current or upcoming market.

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