The Impact on Housing of Higher Mortgage Rates
History suggests sales and house price growth will slow
With the ten-year Treasury yield above 2.0% this morning, and mortgage rates nearing 4%, a key economic question is: What will be the impact on housing of higher mortgage rates?
First, housing is a key transmission channel of Federal Reserve policy. I discussed this back in 2012: Analysis: I expect QE3 on Sept 13th 
[O]ne of the key transmission channels for monetary policy is through residential investment and mortgages.
Of course, in 2012, we were discussing how Fed policy would boost housing. Now, Fed policy - higher rates, halting asset purchases, allowing runoff of assets (not reinvesting), and even selling assets - will slow housing.
Impact on Refinance Activity
For mortgages, an immediate impact of higher rates is less refinance activity. We are already seeing this in the Mortgage Bankers Association’s (MBA) refinance index. From the MBA: Mortgage Applications Decrease in Latest MBA Weekly Survey
The Refinance Index decreased 7 percent from the previous week and was 52 percent lower than the same week one year ago. …
With rates 87 basis points higher than the same week a year ago, refinance applications continued to decrease,” said Joel Kan, MBA’s Associate Vice President of Economic and Industry Forecasting.
This graph shows the refinance index since 1990. With higher mortgage rates, the refinance index has declined sharply over the last several months.
There are two impacts of less refinance activity: first, homeowners can no longer refinance to lower their mortgage payments, thereby increasing their monthly cash flow, and second, homeowners are less able to use their home as an ATM (cash-out refinance) unless they are willing to accepts higher monthly payments. Both of these channels have boosted economic activity during the pandemic.
Impact on New and Existing Home Sales
Looking back at previous periods with similar increases in mortgage rates - like in 2013 when mortgage rates increased from 3.4% to 4.5% from May to July - new home sales fell from about 440 thousand per month to about 390 thousand per month. This was a decline of about 10%.
There was a similar decline in 1994 when rates increased from 7.2% to 8.4%, and new home sales fell from around 730 thousand to 650 thousand. And in 2018, rates increased from around 4.0% to 4.9%, and new home sales declined from around 650 thousand to 590 thousand.
There are other periods when rates increased - like in 1999 - and new home sales only declined slightly. Here is a graph of 30-year mortage rates. The arrows point to the three periods mentioned above.
And here is a graph of new home sales with arrows pointing on the same periods.
The decreases in new home sales during periods of rising mortgage rates mostly look like noise on this graph (there are other factors impacting sales). However, it seems likely - based on history - that we will see a decline in new home sales from recent levels.
And here is a graph of existing home sales with arrows pointing at the same periods of mortgage rate increases. It appears existing home sales also declined around 10% in each of these periods.
There are other factors impacting new and existing home sales, but it seems likely we see some slowing in purchase activity.
Impact on Housing Inventory
Looking back at these previous periods of rising mortgage rates, months-of-supply increased for both existing and new home sales, due to the decrease in sales, but overall inventory didn’t increase significantly.
If sales slow over the next several months, watching inventory will be key. It appears months-of-supply will increase (based on previous periods of rising mortgage rates), but it will be important to watch actual inventory levels.
Impact on House Prices
And what about house prices? Looking at these previous periods of rising mortage rates, we can see that house price growth slowed significantly following the 2013 and 2018 mortgage rate increases. Here is a graph of Case-Shiller house prices with arrows pointing at the three earlier periods of rising rates.
We will probably see house price growth slow in the coming months (perhaps significantly). House price data is released with a lag, so it might take several months before we see the impact on prices.
With 4% 30-year mortgage rates, we will likely see a slowdown in both new and existing home sales (based on previous periods of rising rates). It also seems likely house price growth will slow. However, the impact on inventory is unclear.
An interesting question: Will higher mortgage rates slow investor buying? Higher rates will make buy-to-rent less attractive. Investor buying - and build-to-rent - will be areas to watch.
There is further downside risk if mortgage rates continue to increase, or if we see a significant increase in inventory (something we didn’t see in previous periods of rising mortgage rates).