The Federal Reserve recently announced a 0.75% increase in its benchmark interest rate, which is about to make an already bad housing situation worse.
According to experts, the rate increase will lead to higher interest rates on fixed-term and adjustable-rate mortgages, affecting the ability of would-be homebuyers to pursue them while also leading homebuilders to tamp down production of new homes. The overall cost of housing could come down, but with less supply and increasingly common all-cash buyers, more people will be pushed out of the housing market.
“We are not bullish that increases to the federal fund rate will counteract rapidly deteriorating affordability, access to homeownership, and the fundamental shortage of homes that the nation is facing,” says Mike Kingsella, CEO of the nonprofit advocacy group Up For Growth.
The housing supply is already far below demand. A recent report from Up For Growth finds that there is a nearly 4-million-home shortfall in annual housing production. That figure represents the mismatch of supply and demand from 2019, the most recent year for which data is available. It’s an underproduction issue that’s only been getting worse over time, more than doubling from the 1.6-million-home shortfall in 2012. The pandemic’s impact on supply chains and the cost of construction materials has likely further constrained supply over the past few years, and the interest rate hike will probably constrain it even further.
Kingsella says the situation today is much different than just a few years ago, when interest rates were low, and the cost of labor and materials wasn’t prohibitively high for builders. Since most homebuilders in the U.S. are small businesses, higher-interest rates and pandemic-affected material costs will likely dissuade them from investing in new projects.
“If we fell 3.8 million homes short of meeting housing needs in the best of times, imagine how far we will fall as interest rates broadly increase, and it becomes even more difficult for builders of much needed housing to access loans to produce that product,” he says.
That will also have a trickle down affect on renters, according to Diane Yentel, president and CEO of the National Low Income Housing Coalition. “Increased mortgage rates means fewer home sales and fewer would-be first-time homebuyers, increasing rental demand,” she says. “Increased demand and shrinking supply results in the skyrocketing rents we’re seeing across the country.”
For would-be homebuyers on the lower end of the income spectrum, the rate hike could turn out to be a good thing, according to Bruce Marks. He’s the CEO of the Neighborhood Assistance Corporation of America, a nonprofit homeownership advocacy organization that also provides mortgages with below-market interest rates.
“Sometimes lower rates result in higher housing prices,” Marks says, because more people are able to access loans more easily, increasing the competition for and price of what’s on the market. “With increased rates, the result is lower housing prices.” Through below-market mortgages offered by groups like NACA, lower-income homebuyers may still be able to get into the market with less competition, but that remains to be seen.
“At this point, we’re seeing it as a wash, but it could be a net benefit,” Marks adds.
But both Marks and Kingsella say there are still some systemic issues in the housing market that will persist despite this jump in the interest rate.
On the housing-supply side, Marks says the larger challenge is the aggressive purchasing power of private equity and hedge funds that are buying up large amounts of single-family housing and turning them into rental properties. It’s a problem the country is unlikely to build itself out of, he argues. “Even in the best-case scenario, the amount that we build will be almost totally reduced by these cash buyers,” he says. “You don’t see the government—federal, state, or local—paying enough attention to this.”
Kingsella argues that more supply is needed, but slow-to-change land-use policies are standing in the way. Until those policies change to make it easier to build more, and at higher densities, he says incremental monetary policy changes at the Federal Reserve may be irrelevant. “Interest rates go up and down, lumber prices go up and down, but zoning and land use is forever,” he says. “That is the major driver that has perpetuated and increased the severe shortage of homes.”