The housing market is an ever-evolving landscape that often demands careful consideration before making a purchase. COVID, demographics changes, supply shortages and affordability have all combined to turn the housing market on its head and people have been clamoring for a market “crash”.
One factor that is significantly impacting the real estate market is the interest rate that homebuyers are able to qualify for from their lending institution. Interest rates play a significant role in the real estate market, affecting both buyers and existing homeowners. In recent years, the impact of interest rates housing and the cumulative “lock-in” effect of interest rate hikes has gained attention, by compounding affordability issues and preventing any meaningful price reduction.
The lock-in effect, is acting as this invisible force that is holding property owners back from selling or switching to a new place. It’s a real estate term that describes the feeling of being stuck or restricted because of different things like money, emotions, or just plain logistics. There are all sorts of factors at play here, such as transaction costs, the tricky capital gains taxes, and even that emotional attachment we have to our homes. And let’s not forget about the subpar market conditions, the scarcity of available houses, and personal circumstances that can all contribute to this lock-in effect. But the main culprit for real estate lock-in is interest rates. They’re the ones causing the most trouble and making it harder for people to buy or sell properties.
What is the Government’s role in the housing market?
The Federal Reserve (The Fed) is the central bank of the United States. It is responsible for setting monetary policy, which includes the interest rates that banks charge each other for short-term loans. The Fed uses interest rates to influence the overall economy, and is currently using rate hikes to keep inflation low. The rates set by the Fed directly influence the mortgage rates available to you and me.
How does Lock-In and the Fed intersect?
This is where the lock-in effect really does its damage. The lock-in effect occurs when homeowners are reluctant to sell or refinance their properties due to the fear of losing their existing low-interest-rate mortgages. This is particularly relevant when interest rates are rising or when homeowners have secured mortgages at historically low rates. For our current market, this is exactly what we’re seeing. Prior to the pandemic, interest rates were at historic lows and homebuyers appropriately took advantage. According to Redfin, nearly 20% of homeowners have interest rates below 3%. Compare the amount of homeowners enjoying those low rates with current interest rates that often exceed 7%.
In a vacuum, 3% and 7% may not seem like a big difference, but when it comes to a mortgage, the difference can be quite expensive. A 30 year mortgage on a $350,000 house at 3% will cost $1,500 per month, however that same house at 7% will cost you $900 dollars more per month at $2,400.
So what comes next?
The lock-in effect caused by those pesky interest rates can really put a damper on the real estate market. When folks managed to secure mortgages with interest rates that are way below the current market rates, they now just don’t have much incentive to sell their homes and jump back into the game. This then leads to a lot of people simply staying put, holding off on any home transactions until the market becomes more favorable. That then leads to fewer and fewer homes up for grabs, leaving potential buyers with limited options that are then subject to standard supply and demand forces. It’s no wonder some folks might be hesitant to actively participate in the market or even postpone their homebuying decisions altogether.
What’s the solution for the housing market ?
But here’s the real deal, the true solution to this housing market lock-in is: We need more housing supply, plain and simple. If we could just increase the number of new homes being built, it would go a long way in easing the shortage we’re currently facing. You see, it’s not just about interest rates or people feeling stuck; it’s also about outdated zoning regulations, NIMBY (Not In My Backyard) laws, and the ongoing supply chain issues that have been plaguing the industry. It’s going to take some time for the real estate market to return to normal, but we can start making progress by addressing these underlying issues and focusing on increasing the housing supply.
Will the housing market crash?
We’re actually in a pretty interesting situation right now when it comes to the housing market. We’ve got this prolonged housing shortage going on, and on top of that, employment levels are pretty high. These two factors indicate to me that we have little reason to worry about a market crash. There are way too many people (with stable employment) out there who are itching to get their hands on a home. There are many people out there in a home and can afford their current mortgage payments. For a housing crash to happen, these two groups of people will need to see increased levels of unemployment.
But for now, with employment levels holding strong and people still able to meet their financial obligations, we can breathe a sigh of relief. Sure, some folks might have trouble affording a new home, but overall, we’re in a pretty stable spot. As long as employment stays steady, the market should keep chugging along just fine.
In conclusion, I do not believe we’re going to see a housing market crash. Employment remains strong and the demand remains resilient. If anything, the real estate market is in a bit of a stagnate position, aided by the lock-in effect. When homeowners have locked in those favorable interest rates, they’re less inclined to sell and join the market frenzy. This, in turn, results in fewer options for potential buyers causing the limited supply that is available to be quite expensive. However, the ultimate fix lies in tackling the shortage by boosting housing construction, addressing zoning regulations, overcoming NIMBY hurdles, and resolving supply chain challenges. By doing so, we can pave the way for a healthier and more vibrant real estate market in the future. It may take some time, but with the right steps, we can get there.