Interest rate continues rising, where should the young homebuyers go?
Recently, the Federal Reserve hiked its interest rate by 0.75 percentage points to deal with inflation, leading to the 30-year fixed rate mortgage average jump to an incredible high of 7%, which is the highest since the 2008 economic crisis. This has a great impact on the loanable amount of mortgage loans. For example, a person could afford a 30-year mortgage of $1,800 a month a year ago. They could have borrowed $420,000. Their monthly payment can only borrow $280,000, down 33% from last year[1]. Facing soaring interest rates and high house prices, those potential homebuyers who just saved enough down payment and are ready to buy a house with a mortgage now can only watch the dream of owning their house burst.
Figure 1：30-Year Fixed Rate Mortgage Average in the United States (Source: https://fred.stlouisfed.org/series/MORTGAGE30US)
Is it a good strategy to continue renting and buying a house after two years of price decline?
The longer they rent, the less time they could have on enjoying the wealth creation benefits from owning a property and passing it to the next generation. Because once they own their own houses, the expenditure on housing is relatively small and stable. But renting a house still has to bear the risk of house price fluctuation, which is largely not controllable by them. A large number of renters have paid more than 30% of their income to landlords, and raising house prices will be transferred to their expenditure, having a significant negative impact on disposable income and fewer savings.
How much the house price will fall also depends on the regional mortgage structure. The proportion of households buying houses with mortgage loans is high, and the debt borrowed accounts for a high proportion of household assets. The ratio of debt to income for households in the United States, Britain, and Spain is low, and the impact may be small. But for countries with households that have high debt and interest-bearing loans in Australia, Canada, and Sweden, the result of interest rate increases may be more significant [2].
The hope of buying the first house at a lower price after the crash is still very likely to be dashed. Although housing prices are expected to drop next year based on the rising unemployment rate, the decline will not be as large as expected. Economists at Goldman Sachs predict that by March 2024, house prices will fall by about 5-10% of the peak value in June 2021, but it is unlikely that there will be a similar crash of about 30% as what happened in 2008. In addition, it is estimated that the interest rate will probably rise further, and the decline in housing prices will also endanger other social and economic activities, which will lead to a rise in the unemployment rate and a decline in young people's wages, further reducing their vulnerability to housing. Historical data also shows that the housing ownership rate will decline rather than increase after the recession [3]!
Buy smaller, farther, cheaper houses!
In a paper published in 2022 by Mabille of the INSEAD (European Institute of Business Administration) in Review of Financial Studies, he found that after 2005, the housing ownership rate of young people dropped significantly, and this number fell more in those high-price MSAs[4]. The reason is under the same credit tightening conditions, the maximum loan that young people can borrow from banks in expensive cities is affected more severely than in low-price cities, which affects the young people’s affordability, so young people might choose to buy a house in low-price areas.
Figure 2: Young buyers’ access to homeownership by region (Source: Mabille P, 2022)
Note: Left panel: Changes in 25- to the 44-year-old homeownership rate for low-price (blue) and high-price(red) MSAs in the house price distribution. Middle panel: Changes in average flows of mortgages originated to first-time buyers in low- (blue) and high-price MSAs (red). Right panel: The average age of first-time buyers in the economy is subtracted from the average regional ages to control for long-run changes. Hence, the resultant plotted series are deviations from the economy average in low- (blue) and high-price MSAs (red)
What is the implication of the missing young home buyers?
Both house prices and rents will drop, and the effect of foam bursting in expensive cities may be greater than that in cheap areas. According to Mabille (2022), the economic recession and credit crunch initially led to the decline of house prices at the beginning, and gradually rebound to the level before the recession, but the decline in large MSAs was significantly greater. The trend of rent also shows a similar trend of first falling and then recovering, but the difference is that rent recovers faster. Given the current general trend of working at home, combined with the current interest rate increase environment, has led to greater demand for houses in remote areas, we might reasonably speculate that the current interest rate rise may have a greater impact on the housing price foam burst in large cities than in small cities.
Figure 3: House price and rents response to recession with tight credit (Source: Mabille P, 2022)
Note: Left panel: House price changes in low-price MSAs (blue) and high-price MSAs (red). Mid: Changes in rents (upper panels) of low-price MSAs in blue, Right: Changes in rents (upper panels) of high-price MSAs in red.
The sorting effect of housing owners in big cities is more obvious, and young buyers are replaced by older, richer, and whiter repeat customers. According to NAR’s 2022 Home Buyers and Sellers Generational Trends Report, during the survey year between June 2021 to June 2022, only 26% of all home buyers are first-time buyers. But in the past ten years, this number has been between 30% and 40%, and in 2009 it was as high as 50%. The age of first-time home buyers and repeat buyers also rose to the highest level in history at the age of 36 and 59 respectively. The increase in interest rates also makes people who buy houses with loans less competitive than investors who buy houses with cash. About 27% of repeat customers pay for homes with cash, while only 3% of first-time buyers can provide such quotations. The rise in loan interest rates will further squeeze the possibility of young people owning houses in big cities, while rich middle-aged people are more likely to own homes [5].
For house purchase activities in big cities, now may not be the era of millennials!
Reference:
[1]The Economist: A global house-price slump is coming
https://www.economist.com/lead...
[2]The Economist: Which housing markets are most exposed to the coming interest-rate storm?
https://www.economist.com/fina...
[3]The Economist: Housing markets face a brutal squeeze
https://www.economist.com/fina...
[4]Mabille, P. (2022). The missing home buyers: Regional heterogeneity and credit contractions.The Review of Financial Studies
https://academic.oup.com/rfs/a...
[5]The New York Times: “It’s Never Our Time”: First-Time Home Buyers Face a Brutal Market
https://www.nytimes.com/2022/1...
[6]CNN: A house price slump is coming. Rising unemployment could make it much worse
https://edition.cnn.com/2022/1...
[7]CNN: First-time homebuyers are being shut out of the market like never before https://edition.cnn.com/2022/1...
