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What happens if interest rate continues increasing

Several reports showed home prices continue to increase as affordability falls, however affordability will plummet even more next year.

The Federal Reserve plans to raise interest rates once more this year, and several times over the next couple of years. Currently, the 30-year fixed-rate mortgage hovers near 4%. A new report from Arch MI gives the scenario if interest rates increase to 5% or 6%.

The report shows the U.S. median existing home price is $246,000. The corresponding $1,200 monthly mortgage payment would require 25% of the median household’s $58,000 a year in pre-tax income.

However, if rates rise to 5%, the median debt-to-income increases 2% to 27% for the U.S. overall. In Texas, median DTI would increase from 21% to 23%, however California’s would increase from 46% to 50%.

If rates increase to 6%, the median DTI would increase to 31% for the U.S., 26% for Texas and 56% for California.

The chart below shows the decrease in affordability for the two scenarios.

Click to Enlarge

Affordability

(Source: Arch MI)

However, the report explains these increases, while drastic, are increasing from the current historical lows. From the report:

While large projected increases seem dramatic after a long period of mortgage rates hovering near historic lows, thankfully median DTIs are currently lower than their historical averages in most areas. For the United States overall, median DTI would just move up to the historical average since 1975. For median DTI to be similar to the “normal” years (1990 to 2004), rates need to be around 5.5%.

While home prices peaked in 2007, total housing costs peaked much before that in the 1980s when interest rates spiked to nearly 18%, the report explains. Housing costs hit a low in 2012 to 2013 as home prices and interest rates fell after the crash.

Since then, affordability worsened as home prices increased faster than incomes. But while interest rates will increase to an estimated 5% by the end of 2018 and 6% by the end of 2019, most economists expect home price growth will also slow to between 2% and 4% once rates begin to rise.

But while home price increases may slow, there is little chance of seeing them fall through 2018. The average probability that home prices will decrease in America’s largest 400 cities remains unusually low at 4%.

The map below shows the states that are most at risk of home prices dropping.

Click to Enlarge

Affordability

(Source: Arch MI)

The Arch MI Risk Index estimates the probability home prices will be lower in two years, times 100. The higher the Risk Index value, the more likely an area is to experience slower than normal economic and home price growth, and the more likely it is to see outright home price declines.


Many would-be buyers sitting on the sidelines

Houses sunset

Although homes continued selling at a record pace, existing home sales dropped in June due to low levels of inventory, according to the latest report from the National Association of Realtors.

Total existing home sales, completed transactions that include single-family homes, townhomes, condominiums and co-ops, decreased 1.8% to a seasonally adjusted annual rate of 5.52 million in June. This is down from 5.62 million in May.

Despite this monthly decrease to the second lowest level of 2017, the sales pace is still up 0.7% from last year.

“Closings were down in most of the country last month because interested buyers are being tripped up by supply that remains stuck at a meager level and price growth that’s straining their budget,” NAR Chief Economist Lawrence Yun said. “The demand for buying a home is as strong as it has been since before the Great Recession.”

“Listings in the affordable price range continue to be scooped up rapidly, but the severe housing shortages inflicting many markets are keeping a large segment of would-be buyers on the sidelines,” Yun said. “The good news is that sales are still running slightly above last year’s pace despite these persistent market challenges.”

Home prices continue to rise, increasing 6.5% from last year’s $247,600 to $263,800 in June 2017. This increase surpassed May as the new peak, and marks the 64th consecutive month of annual gains.

Total housing inventory dropped 0.5% from May and 7.1% from June last year to 1.96 million existing homes available for sale. Inventory has now fallen annually for 25 consecutive months. Unsold housing inventory rests at a 4.3-month supply, down from 4.6 months a year ago.

“It’s shaping up to be another year of below average sales to first-time buyers despite a healthy economy that continues to create jobs,” Yun said. “Worsening supply and affordability conditions in many markets have unfortunately put a temporary hold on many aspiring buyers’ dreams of owning a home this year.”

Properties stayed on the market for an average 28 days in June, up from May’s 27 days but down from 34 days last year.


Millennials, first-time buyers hit the hardest


house case

Existing home sales dropped in June as housing inventory was unable to keep up with the increasing demand for homes.

Housing demand continues to increase, one expert explained, suggesting existing home sales could increase once again later this year.

“There are several factors that are helping to boost housing demand, including: solid job gains, faster household formations, and low mortgage rates, and these suggest that existing home sales should move higher as the year progresses,” Nationwide Chief Economist David Berson said.

One expert put the amount of housing demand into perspective, and explained two possible outcomes for homebuyers due to low inventory levels and high demand.

“There are about as many homes for sale now as there were in 1994, except there are about 63 million more people in this country now than there were then,” Zillow Chief Economist Svenja Gudell said. “A combination of very low inventory and very high demand leads to two main outcomes, neither of which is particularly favorable for stressed home buyers desperate to make a deal.”

“First, those homes that are available to buy are often on and then off the market in a flash, in many cases staying on the market for only a few short days before going pending,” Gudell said. “High demand and low inventory also serves to push prices higher at a rapid clip, as bidding wars break out for those scant few homes available.”

The chart below from Trulia shows how existing home sales in June compare to the pre-recession average.

Click to Enlarge

existing home sales

(Source: Trulia)

“The quickening pace of existing homes sales indicates a robust demand for homes,” Trulia Senior Economist Cheryl Young said. “Steady mortgage rates will continue to encourage demand even in an environment of high prices and little supply. As a result, home buyers are snatching up inventory at rates near equal to the pre-recession peak.”

One economist explained first time homebuyers and other groups looking for affordable housing are the most effected by the inventory shortage.

“This situation primarily affects low to moderate priced home buyers, including millennials, first-time buyers and people of modest means,” realtor.com Senior Economist Joseph Kirchner said. “These groups have had extreme difficulty finding homes and the plummeting sales we have seen for months isn’t showing signs of slowing soon.”


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