In U.S., expect mortgage rates, home sales and prices to rise

Nate Lowenstein has been shopping for a home in Los Angeles, on and off, for more than a year.

But his search has been stymied by a stubbornly low roster of homes on the market and the hurdles that come with it: multiple competing bids and higher prices.

“It’s not a great market, from a buyer’s perspective,” said Lowenstein, a lawyer. “The one good thing is that interest rates were quite low.”

As recently as this summer, homebuyers had ultra-low mortgage rates on their side. That’s good news for any borrower, especially for those in expensive housing markets like Los Angeles, Boston and Seattle.

But that was then.

Now, mortgage rates remain low by historical standards but they’ve risen sharply over the past couple of months, pushing the average rate on a 30-year, fixed-rate mortgage to 4.32% this week. That’s the highest level since April 2014 and well above the year’s average of 3.65%.

Further, economists predict mortgage rates will continue to climb next year–just one of the trends that suggest 2017 could be a more challenging year for homebuyers.

“With higher mortgage rates, you’re increasing the cost, [and] challenging the budgets [and] ability to qualify. As a result, likely reducing somewhat the pool of potential buyers,” said Jonathan Smoke, chief economist for Realtor.com.

So far, the rate increases have not begun to worry Lowenstein, who is in the market for a house with at least three bedrooms in L.A.’s affluent west side. His budget is between $1.6 million and $1.8 million.

“We’re not priced out yet,” Lowenstein said. “But if it goes up to 5 per cent or 6 per cent, at some point we would be.”

Long-term mortgage rates tend to track the yield on the 10-year U.S. Treasury note. The yield goes down when investors bid up bond prices, as they did following this summer’s vote in Britain to exit the European Union. The move sent long-term mortgage rates tumbling as low as 3.41%.

The reverse happened after election day in November, when a sell-off in U.S. bonds drove the yield on the 10-year Treasury note to the highest level in more than two years. Mortgage rates have been inching higher ever since.

But will they continue to do so?

Smoke predicts mortgage rates will reach 4.5% in 2017. Other economists expect rates will remain above 4% but not go beyond 5% next year. That range would mean mortgage rates that would be low compared to the last decade.

Average long-term mortgage rates were above 6% during the height of the last housing boom and they hadn’t hit 5% before 2008.

So someone looking to buy a home in the next few months doesn’t need to panic, said Svenja Gudell, chief economist at Zillow, a real estate information company. “My advice to buyers would be to not freak out and feel a sense of urgency,” she says. “If you aren’t able to buy a house at 4.5 per cent, you probably weren’t able to buy a house at 4 per cent.”

The stakes are a bit higher for buyers in expensive markets, where housing can eat up a much larger share of household income.

But, if mortgage rates continue to climb, there are moves would-be homebuyers can make to better offset some of the higher borrowing costs.

Consider lowering the interest rate by paying a fee to the lender up front, something known as buying down the interest rate. Or go with an adjustable-rate mortgage, which has a low, fixed-interest rate for a few years, typically five or 10, then adjusts to a higher rate.

Another move is to ask the seller to pay the buyer’s closing costs. That can free up more cash for buyers to manage the higher borrowing costs.

One upside

Higher mortgage rates could have one silver lining: as some buyers are priced out, sellers may have to be more flexible on prices. Over time, that could help stem home prices.

Low inventory and strong demand helped push prices higher in 2016 at the fastest pace in 10 years, according to an analysis by Zillow. The company predicts that U.S. home prices increase about 3% in 2017, down from a gain of about 6.5% this year.

Declining affordability is one reason the National Association of Realtors predicts U.S. homes sales will rise 2% next year. Compare that to the 15% increase in sales through the first 11 months of 2016.

Even buyers who can weather higher mortgage rates may have to brace for a long home search next year.

The inventory of homes for sale is expected to be tighter in 2017 than it was this year. While it varies by market, nationally, fewer than 1.9 million homes were on the market in November, down 9% from a year earlier, according to the NAR.

Homebuilders are not building enough homes to make up for the shortage, citing a lack of ready-to-build land, labour shortages and rising building materials costs.

Homebuyers can also expect to face more competition in 2017 as millennials continue to transition from renting to homeownership, particularly in more affordable markets in the Midwest and South.

First-time buyers accounted for roughly 32% of home purchases through the first 11 months of 2016, up from 30% in the same period a year earlier, according to the NAR.

Affordability remains a hurdle for many first-time buyers, but qualifying for financing may get a bit more accessible in 2017.

Fannie Mae and Freddie Mac will increased the limit of the mortgages they will buy from lenders next year to $424,100 from $417,000. In more expensive markets, the mortgage giants will accept loans as high as $636,150, up from $625,500.

Banks may also have an incentive to loosen lending standards if rising mortgage rates continue to dampen demand for mortgage refinancing.