The Reduction Of Interest Rates Explained
As we all know the recent reduction in interest rates could have significant implications for the real estate market, particularly in the residential sector. Lower interest rates tend to decrease the cost of borrowing, making mortgages more affordable for potential homebuyers. Historically, this often leads to increased demand for housing, as lower monthly payments enable more people to qualify for loans and afford higher-priced homes. As a result, many markets may experience renewed competition among buyers, potentially driving up home prices, especially in areas with limited housing supply. This rate reduction can also motivate homeowners to refinance their existing mortgages, freeing up disposable income and boosting overall consumer spending. Let’s dissect these assumptions a little as they relate to our current environment.
So now that we have realized the Federal Reserve reducing the interest rate a significant ½ of a point, how will it impact buyer purchase demand and thus originations. Obviously, we have two sectors to talk about, purchases and refinances.
As for refinance opportunities, according to Redfin nearly 90 percent of American homeowners have properties where the cost of their mortgage is below 6 percent which is cheaper than what the current market is offering. This helps explain why the refinancing share of mortgage applications has been so low. Having said that, there are an extremely high number of adjustable mortgages scheduled to reset in 2024 and 2025. The average rate for a 5-year ARM, in which rates adjust annually after the first five years, was at 6.29 percent.
On the home purchase it will be interesting to see how buyer demand will be influenced. In recent articles we discussed some concerns and questioned how potential buyers would respond to decreased fed rates. To that point mortgage rates ticked down for the third week in a row, the 30-year fixed-rate mortgage averaged 6.08% as of Sept. 26, according to data released by Freddie Mac on Thursday. That’s the lowest level since mid-September 2022 however buyers are taking their time before they jump in. Many are stating they are waiting and hoping for additional interest rate reductions. Nonetheless, industry data sources suggest that home-buying activity could pick up very soon. Touring activity, a proxy for home-buying interest, is up 8%, real-estate brokerage Redfin reported.
One obvious issue is housing supply and high prices. As Federal Reserve chair Jerome Powell said last week the “real issue” behind high prices in the U.S. housing market is a lack of supply, which isn’t “something the Fed can really fix.” There is currently a shortage of about 4 million homes in the U.S., according to the National Association of Realtors’ most recent projections. As such, the imbalance between supply and demand will continue to put upward pressure on prices. Although that gap is significantly lower than in recent history many builders indicated in late 2023 and into 2024 that they have been hesitant due to concerns over potential lack of buyer demand. It will be interesting to see how the rate reduction will impact their near future strategies. The other factor is that higher interest rates have made it unappealing to sell for those already invested in the housing market. Many homeowners are locked into lower rates and subsequently lower mortgage payments than they could get when buying another house today, sometimes described as a “lock-in” period. How will this change? Some experts anticipate that lower mortgage rates could boost home-buying and selling activity. When market activity heats up, it could push home values higher at a faster rates as well, similar to the frenzied market seen from 2020 to early 2022. One other thing to consider as we measure transaction levels in the next two quarters is that we are past the traditional buying season. Will that rate reduction extend that next cycle in the next two quarters?
Lastly is the state of the economy. Top White House economic adviser Lael Brainard last week declared that the U.S. economy had turned the corner in bringing down inflation and it was now time to focus on safeguarding recent progress in the labor market. Still, the effects of the pandemic linger. The combination of high inflation, increased borrowing costs, and a higher unemployment rate—currently at 4.2%—has led to a significant drop in personal savings. Nearly 10% of credit card balances and 8% of auto loans are currently overdue. These numbers mark the highest credit card delinquency rates in over a decade. This in a time with continuing high cost of living. Shelter costs, which make up around a third of total spending, are still high relative to the Fed’s overall target of 2%, with a year-over-year increase of 5.2% as of August, according to the Consumer Price Index. On thing we have not talked about is how homeowners’ insurance is escalating out of control. Millions of Americans face rising homeowners’ insurance rates as natural disasters linked to climate change increase costs for insurers. Home insurance rates around the nation jumped an average of 11.3%in 2023, with some states seeing spikes of more than 20%, according to S&P Global Market Intelligence. I can speak personally about the struggle in California to obtain home insurance at all as many companies are leaving the state.
In conclusion, the impact of interest rate reductions on mortgage originations and the real estate market isn’t uniform and can vary depending on regional conditions and broader economic factors. While lower rates generally promote growth and stability in property values, there are risks associated with them, such as overheating in certain markets and increased household debt levels. Moreover, if the rate cuts are perceived as a response to economic weakness, it could dampen overall confidence in the market, offsetting some of the positive effects. Once again, we are in uncharted territory and I for one will be eager to watch as we go into 2025.
Michael Harris is Managing Director and Partner of the Servicing Practice at BlackFin Group. Michael has over 20 years’ senior executive management experience in default servicing and mortgage servicing. He and his team are subject matter in all aspects of servicing strategy, investor relations, process, compliance requirements. Prior to BlackFin, Michael was the President & CEO of Jennick Asset Management and was responsible for developing the pilot outsourced management program for Fannie Mae, Freddie Mac, and HUD while working with the top 10 mortgage servicing and capital markets firms. For more information contact [email protected]
