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Mortgage rates hit 5 percent, ushering in new economic uncertainty

Rates have risen faster than many economists had expected, and they are starting to temper the housing boom

Mortgage rates have been climbing steadily for months. (Wilfredo Lee/AP)
7 min

Mortgage rates swelled above 5 percent for the first time in more than a decade — an unexpectedly rapid ascent that has begun to temper the U.S. housing boom and could usher new uncertainty into an economy dogged by soaring inflation.

The 30-year fixed-rate mortgage, the most popular home loan product, hit the threshold just five weeks after surpassing 4 percent, according to Freddie Mac data released Thursday. The average has not been this high since February 2011.

The run-up comes as the Federal Reserve has launched a major initiative to rein in the highest inflation in 40 years. Fed officials are betting that higher interest rates will slash inflation and recalibrate the job market. But their plan also rests on the assumption that higher rates will cool demand for housing, especially while homes themselves are in such short supply.

Low rates fueled the revival of the U.S. housing market after the Great Recession and have helped drive home prices to record levels. But after two years of hovering at historical lows, rates have been on a tear: In January, the 30-year fixed average was 3.22 percent. It was 3.04 percent a year ago. And while mortgage rates had been expected to rise, they’ve done so more quickly than many economists predicted.

“I’m not surprised that rates have hit 5 percent, but I am surprised that everyone else is surprised,” Curtis Wood, founder and chief executive of Bee, a mobile mortgage app, said via email. “If you look at historical action by the Fed in a high-rate environment and compare that to what the Fed is doing today, the Fed is underreacting to the reality of inflation in the economy.

“I’m surprised that rates aren’t at 6 percent right now,” he added, “and wouldn’t be shocked if they’re at 7 percent by end of year.”

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Consumers have been absorbing higher prices in nearly every facet of their lives, with essentials such as food and gasoline spiking 8.8 percent and 48 percent, respectively, compared with last year. But higher mortgage rates can significantly limit what they can buy, or price them out altogether.

Several months ago, a home buyer would be looking to pay $1,347 a month on a $300,000 loan at 3.5 percent interest. But if the buyer had waited until this week, the same loan at 5 percent would tack on $263, bringing the monthly payment to $1,610.

The Federal Reserve’s efforts to tame inflation are driving the rise in rates. Although the Fed does not set mortgage rates, it does influence them. The central bank took its first steps toward bringing down inflation in March when it raised its benchmark rate for the first time since 2018. In addition to the federal funds rate hike, the Fed is soon to begin the process of reducing its balance sheet.

The Federal Reserve holds about $2.74 trillion in mortgage-backed securities. It indicated it will reveal its plans for reducing its holdings at its May meeting. The more aggressively the Fed sells those bonds, the faster mortgage rates are likely to rise.

The cost of housing doesn’t only weigh on buyers and sellers. It also has proved to be a major complication for the economic recovery, and potentially jeopardizes policymakers’ ability to rein in soaring inflation.

Inflation is rising at the fastest pace in 40 years, with prices climbing 8.5 percent in March compared with the year before. Shelter is a major part — roughly one third — of the basket of goods and services used to calculate inflation, or what’s known as the consumer price index. That means that if housing costs don’t meaningfully turn around soon, it will be that much harder for overall inflation to simmer down to more normal levels.

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Shelter costs also stand apart from other categories, such as gas, food or plane tickets, that may be more susceptible to forces like the ongoing coronavirus pandemic, supply chain disruptions or a war.

For example, it’s unlikely that gas or energy prices will remain as high as they were when Russia invaded Ukraine and rattled global energy markets. Food also may become cheaper as supply chains smooth out over time.

But those forces don’t apply to housing costs in the same way. Landlords that can lock in higher rents are unlikely to shave prices a year later. Buyers will continue to clamor for the few homes available. And as the housing market has been supercharged by bidding wars and all-cash offers, it’s unclear how drastically demand will have to cool before the cost of housing will meaningfully turn around.

Even Fed officials are riding the wave. This week, Fed Governor Christopher Waller said he sold his house in St. Louis to an all-cash buyer with no inspection.

“The national housing market is beyond belief,” Waller said at a community listening session Monday hosted by the Fed.

It was the Fed’s actions during the pandemic that drove down mortgage rates. The 30-year fixed average bottomed out at 2.65 percent in January 2021. By lowering the federal funds rate to near zero and buying Treasurys and mortgage-backed securities to prop up the economy, the central bank ushered in an era of cheap home loans.

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When borrowing became less expensive, home prices rose as buyers could afford to spend more on housing. The most recent Case-Shiller housing index showed prices swelled 19.2 percent in January, year over year. Phoenix, Tampa and Miami saw increases of 32.6 percent, 30.8 percent and 28.1 percent, respectively.

The median price, meanwhile, climbed to $357,300 in February, according to the National Association of Realtors. That represents a 15 percent premium over last year and 120 consecutive months of year-over-year price increases, the longest streak on record.

Prices should moderate, but rising interest rates will continue to make affordability a challenge. And though higher rates are expected to slow home-buying over time, the factors that have led to the housing boom remain. Inventory remains low and demand remains high.

“We’ve already seen buyer activity slow in terms of seeing fewer home sales,” said Lisa Sturtevant, a housing market analyst in Alexandria, Va. “Part of that has to do with there’s not enough to buy. I think we’re probably going to see a pretty strong spring as people are trying to get in before they think rates are going to go even higher.”

With the increase in rates, the mortgage market’s boom in 2020 and 2021 has slowed this year. Refinancing applications have declined to the lowest level since 2019. The Mortgage Bankers Association is forecasting that overall originations will fall by more than 35 percent this year. Purchase originations are expected to rise 4 percent but refinance originations are predicted to fall 64 percent.

“The jump in mortgage rates will slow the housing market and further reduce refinance demand the rest of this year,” Mike Fratantoni, the association’s chief economist, said in a statement. “Higher home prices and rates as well as ongoing supply constraints are now expected to lead to an annual decline in existing home sales.”