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Rising mortgage rates, lack of properties causing headaches for US home buyers

Real estate agent Lauren Newman, right, prepares to show Steve Martin a home for sale in Mount Pleasant, S.C., just over the bridge from historic Charleston. .
Real estate agent Lauren Newman, right, prepares to show Steve Martin a home for sale in Mount Pleasant, S.C., just over the bridge from historic Charleston. .

It’s been more than a year since Nate Lowenstein started shopping for a home, and he’s grown frustrated by the scant number of homes on the market. Like many house hunters in Los Angeles, he also complains sellers are unwilling to budge on prices, emboldened by offers from multiple bidders.

“It’s not a great market, from a buyer’s perspective,” said Lowenstein, a lawyer. “The one good thing is that interest rates were quite low.”

Until they weren’t.

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Mortgage rates have risen sharply since Election Day, to an average 4.32 per cent on a 30-year, fixed-rate mortgage last week. While still low by historical standards, that’s the highest since April 2014 and well above the year’s average of 3.65 per cent. The difference translates into an extra $1,852 a year in payments on a 30-year, fixed-rate loan for $400,000, for example.

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Climbing rates are just one of the challenges economists predict for homebuyers this year. They also anticipate the supply of homes for sale will remain tight in many cities, and that buyers will face increased competition as more millennials shift from renting to homeownership. Economists also forecast home prices will rise again this year, albeit more slowly than in 2016.

READ MORE: Priced out of the housing market? Here are your options

“With higher mortgage rates, you’re increasing the cost, challenging the budgets, challenging the ability to qualify and, as a result, likely reducing somewhat the pool of potential buyers,” said Jonathan Smoke, chief economist for Realtor.com.

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So far, the rate increases have not begun to worry Lowenstein. He and his wife, also a lawyer, are in the market for a house with at least three bedrooms in L.A.’s affluent west side. Their budget: Between $1.6 million and $1.8 million.

“We’re not priced out yet, but if it goes up to 5 per cent or 6 per cent, at some point we would be,” said Lowenstein, 38.

RATES HEADED HIGHER?

Long-term mortgage rates tend to track the yield on the 10-year U.S. Treasury note. The yield goes down when investors bid up bond prices, as they did following this summer’s vote in Britain to exit the European Union. The move sent long-term mortgage rates tumbling as low as 3.41 per cent.

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The reverse happened after Election Day. Investors bet that a Republican-controlled White House and Congress will have a clear path to implement policies that will drive inflation and interest rates higher. A sell-off in U.S. bonds drove the yield on the 10-year Treasury note to the highest level in more than two years. Mortgage rates have been inching higher ever since.

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Homebuyers and owners brace for rising mortgage rates
Homebuyers and owners brace for rising mortgage rates

But will they continue to do so?

Smoke predicts mortgage rates will reach 4.5 per cent in 2017. Other economists expect rates will remain above 4 per cent but not go beyond 5 per cent next year.

That’s still low compared to the last decade. Rates didn’t dip below 5 per cent before 2008.

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So someone looking to buy a home in the next few months doesn’t need to panic, said Svenja Gudell, chief economist at Zillow, a real estate information company.

“My advice to buyers would be to not freak out and feel a sense of urgency,” she said. “If you aren’t able to buy a house at 4.5 per cent, you probably weren’t able to buy a house at 4 per cent.”

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The stakes are higher for buyers in expensive markets, where housing can eat up a much larger share of household income.

BUYERS HAVE OPTIONS

To offset some of the higher borrowing costs, homebuyers could consider lowering the interest rate by paying a fee to the lender up front, something known as buying down the interest rate. This strategy makes the most financial sense for buyers planning on staying in the home for many years.

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For owners looking to sell within a few years, an adjustable-rate mortgage can be an attractive alternative. ARMs have a low, fixed-interest rate for a few years, typically five or 10. The rate then adjusts to a higher rate.

Another move: Ask the seller to pay closing costs, which would free up cash for buyers to manage the higher borrowing costs. Buyers may have better luck with this tactic in markets where there is less competition and sellers are more motivated.

SILVER LINING?

If rising mortgage rates deter homebuyers, that could eventually stem the rise in home prices.

Last year, the 6.5 per cent gain in U.S. home prices was the highest in 10 years, according to an analysis by Zillow. The company predicts an increase of about 3 per cent in 2017.

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Declining affordability is one reason the National Association of Realtors predicts U.S. homes sales will rise just 2 per cent this year. Compare that to the 15 per cent increase in sales through the first 11 months of 2016.

TIGHT MARKET

Don’t expect the housing market to get any less competitive in 2017.

The number of homes for sale nationwide declined in November for the 18th month in a row, according to the NAR. At the current sales pace, it would take just four months to buy up all the homes on the market. A market that’s balanced between buyers and sellers typically has at least a six-month supply.

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Homebuilders are not building enough homes to make up for the shortage, citing a lack of ready-to-build land, labour shortages and rising building materials costs.

MILLENNIALS BECOME BUYERS

Homebuyers can also expect to face more competition this year as millennials transition from renting to homeownership, particularly in more affordable markets in the Midwest and South.

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First-time buyers accounted for roughly 32 per cent of home purchases through the first 11 months of 2016, up from 30 per cent in the same period a year earlier, according to the NAR.

READ MORE: Soaring prices smash young Canadians’ home ownership dreams

Affordability should be less of a hurdle for many first-time buyers, as qualifying for financing gets a bit more accessible.

The size of the mortgages Fannie Mae and Freddie Mac will buy from lenders rises this year to $424,100 from $417,000. In more expensive markets, the mortgage giants will now accept loans as high as $636,150, up from $625,500.

Banks may also have an incentive to loosen lending standards if rising mortgage rates continue to dampen demand for mortgage refinancing.