A fascinating phenomenon is unfolding in the housing market, and it's time to unravel the story behind it. The housing market is slowly recovering from a unique and controversial situation, and it's all about those ultra-low mortgage rates.
Imagine having a mortgage with an interest rate below 4%, and yet, many homeowners are choosing to hold on to these rates, even as life circumstances change. But here's where it gets controversial... as these homeowners reluctantly sell their homes, the market is slowly unlocking, and the share of these below-4% mortgages is shrinking.
According to the Federal Housing Finance Agency (FHFA), the share of mortgages with interest rates below 3% has declined to 20.0% in Q3, the smallest percentage since Q1 2021. This decline is a result of the Fed's interest rate repression and asset purchases, which created a refinancing tsunami in 2020 and 2022. All types of mortgages, from 30-year fixed to adjustable-rate mortgages, are included in this data.
Combined, the share of mortgages with interest rates below 4% has dropped to 51.5%, the lowest since Q4 2020. This is a significant shift, as homeowners face life changes and decide to sell, letting go of these incredibly low-interest mortgages. At the peak in Q1 2022, over 65% of mortgages had rates below 4%, so this decline is notable.
And this is the part most people miss... the impact of adjustable-rate mortgages (ARMs). Homeowners with ARMs experienced payment shock as rates began to rise in 2022, but now, that phase is mostly over. The share of ARMs has been low since 2021, and some ARMs even had rates below 3% before 2020, which influenced the overall mortgage rate data.
When mortgage rates plunged in 2020, many homeowners refinanced, but not all could get rates below 4%. Homeowners with higher rates, perhaps due to credit score issues, refinanced into the 4% to 5% range, while others with lower rates moved into the sub-4% category. This created a shift in mortgage rate distribution.
The share of mortgages with rates between 5% and 6% has remained relatively stable, at around 10%, with many fixed-rate mortgages offered in this range. However, the share of mortgages with rates above 6% has increased to 21.2% in Q3, the highest since Q3 2015. This shift highlights the impact of the Fed's monetary policies and the subsequent housing market adjustments.
Below 3% mortgages were essentially free money in real terms, as inflation ran at about 3%, making these mortgages equivalent to borrowing at no cost. This led to an explosion in home prices, with many markets seeing increases of 50% or more in just two years. Now, with these ultra-low-interest-rate mortgages, homeowners are locked into their homes, hesitant to sell and buy more expensive properties with higher interest rates.
This lock-in effect has impacted real estate brokers and mortgage lenders, as transactions and originations have declined, leading to mass layoffs and departures. However, life's changes persist, and some locked-in homes are being sold, slowly unlocking the market. The average 30-year fixed mortgage rate was below CPI inflation in 2021 and 2022, creating negative real mortgage rates, an unprecedented situation.
At the peak of this craziness, real mortgage rates were 4 percentage points below CPI, with an average 30-year fixed rate below 3% and CPI inflation exceeding 7%. These negative real mortgage rates fueled a historic home price explosion, which is now being unwound in many markets.
So, what's your take on this? Do you think the housing market will fully recover, or will these ultra-low mortgage rates continue to impact the market? Share your thoughts in the comments below!
