Today’s homeowners are stuck on yesterday’s rates

Something’s missing in 2023’s housing market. Actually, a lot of somethings are missing.

Home sales volume is down 31% from a year earlier as of June 2023, as real estate agents feel the damage of fewer homebuyers, sellers and for-sale inventory on their incomes.

Where is everyone? And when will they return?

The answer is found in the long-term cyclical rise in mortgage rates which has stymied not only buyer purchasing power, but also sellers’ willingness to list and purchase replacement property.

Of today’s mortgaged homeowners:

• 92% have an interest rate below 6%;
• 82% have an interest rate below 5%;
• 62% have an interest rate below 4%; and
• 24% have an interest rate below 3%, according to Redfin.

In contrast, homeowners purchasing today will find the average 30-year fixed rate mortgage (FRM) hovering over 7.0% as of August 2023.

Homeowners with interest rates below 5% — the vast majority of mortgaged homeowners — are half as likely to sell as those with an interest rate higher than 5%, according to Zillow.

For example, consider a homeowner who purchased a home for $600,000 with a $100,000 down payment during 2021 when mortgage interest rates were near historic lows. Now, in 2023, they are considering selling to relocate for a better job. Their $500,000 mortgage originated in 2021 at 3.0% means they have been paying a monthly principal payment of $2,100.

When they sell and move, they demand a home of similar quality and size. But at today’s 7.0% rate, a $500,000 mortgage will result in a monthly principal payment of $3,300 – when they can qualify for that amount.

Further, home values have increased on average 14% in California since mid-2021, meaning their home’s equity has increased roughly $86,000. While this may offer them a larger down payment to invest in their next home, after closing costs, improvements and moving costs, the increase in equity is null.

With an increase of $1,200 monthly due to the higher rate alone, the homeowner is unable to qualify.

They decide to hold onto their home with the low interest rate and turn down the better job, leaving their home off the market.

Buyer purchasing power influences sellers, too

On average, a homebuyer with the same income is able to borrow 11% less purchase-assist mortgage money than a year ago when mortgage interest rates were well into their rise from historic lows.

Compared to two years ago, this same homebuyer is limited to borrowing a significant 35% less. The only remedy for this potential seller/homebuyer is to either:

• pay a significantly higher mortgage payment (for which they do not usually qualify);
• downgrade their housing (unlikely); or
• stay put, keeping their home off the market.

Mathematically, home prices received by sellers eventually need to absorb the change in borrowed funds available to buyers — based on FRM rates and 31% of a buyer’s gross income.

But in 2023, the inventory of homes available is so low that sellers are briefly able to hold on to their sticky price notions which keep home prices from falling to meet buyer purchasing power levels.

But the impact to home prices — which began in 2022, pausing for Spring 2023’s seasonal bounce — is inevitable.

Related article:

Press Release: Despite steady gains, Q2 2023 Buyer Purchasing Power Index still negative

 

Seller reluctance fuels the inventory shortage

In our example, the seller’s (understandable) reluctance to list results in one less home for sale on the multiple listing service (MLS) than would otherwise have been made available to homebuyers under yesterday’s regime of lower interest rates.

This situation has played out at a large scale, with the number of new listings down 30%-35% across California’s major metros from a year earlier as of May 2023.

The consequence has been an extreme reduction in MLS inventory — an illusion of buyer demand and a mask for the housing market’s recession.

However, watch for inventory to climb gradually in 2023. Turnover of ownership is constantly taking place.  Owners who ought to be selling now and are not will come to the market in the next several months.

The significant mortgage interest rate increases of 2022 have slashed buyer purchasing power, making it nigh on impossible for mortgaged homebuyers to participate at today’s still-high asking prices. While sellers are also unwilling to list and repurchase in today’s high interest rate environment, the economic recession expected to arrive in the second half of 2023 (ushering in job losses) will push many would-be sellers into the position of forced sellers.

Then, as inventory grows and home prices continue their downward trend, homebuyers will increasingly take a wait-and-see approach to buying and the price drop will snowball.

Since the market will soon be firmly in the hands of buyers, real estate agents who wish to maintain a steady income in 2024-2025 will turn their focus to finding those buyers who are willing and able to buy during the downturn.

Related article:

California’s for sale inventory: a symptom of seller reluctance in 2023