by Brad Houle, CFA
Principal Fixed Income Research and Portfolio Management
One topic we are consistently asked about is the risk of another housing crisis. Housing is clearly softening in the wake of the increases in interest rates, causing mortgage rates to climb sharply this year and making home ownership unaffordable for many Americans. In January of 2022, a 30-year mortgage was 3.4% climbing to 6.4% by December. Mortgage rates are largely determined by the interest rate of the 10-year U.S. treasury. Treasury bond interest rates have also climbed sharply this year due to both the influence of the Federal Reserve aggressively increasing of short-term interest rates, as well as the elevated rate of inflation.
We do expect to see declines in housing prices over the next couple of years. The sharp run up of home prices as a result of nearly zero interest rates, excess demand driven by the COVID-19 pandemic and people looking for more space will be reversed in some cases. As housing markets are local markets, we expect to see a variability in price declines dependent on local market conditions. Cities such as San Francisco, that had excessive increases in home prices prior to the COVID-19 pandemic that are now suffering from out-migration due to remote work preferences and high cost of living, are most at risk.
Bloomberg Economics forecasts as much as a 15% decline in home prices over the next two years. While this is a sharp decline, we do not believe that it will cause another financial crisis due to quality mortgage underwriting and a lack of variable rate mortgages. In 2008, 35% of outstanding mortgages were variable contrasted with 5% today. Additionally, 65% of mortgage originations today are borrowers with a FICO score over 760; 15 years ago, only 25% of borrowers had a score that strong.
Despite the sharp increase in mortgage rates, most homeowners have fixed rate mortgages locked in at meaningfully lower rates (the average mortgage payment is roughly $1200, the same as it was 15 years ago). This is due to an average mortgage rate of 3.25%, which is roughly half of today’s current rate. Therefore, we do not expect to see the level of defaults and foreclosures that you would see in other periods of economic and housing softness.
There has been a lack of investment in housing since the financial crisis. Housing starts peaked in 2006 at more than 2 million units and have never reached that level again.
Source: Census and Bloomberg Intelligence
With growth in population and millennials reaching the age of new household formation, we believe there is a pent-up demand for housing by millennials that would like to buy their first home when the cost of financing becomes more affordable. Our view is that we have seen the peak in long-term interest rates for this cycle and therefore, the peak in mortgage rates. Ultimately, this pent-up demand for housing and a lack of new supply should help mitigate the declines in home prices.
Takeaways for the Week:
We do believe there will be softness in housing prices over the next couple of years - pent up demand and stronger borrower credit should keep the prices declines from becoming a crisis.