Mortgage Rates Surpass Seven Percent
As of Friday, October 30th, the 30-year fixed mortgage rate has soared to a more than a two decade high of 7.32%. The Federal Reserve (the FED), in an effort to bring down inflation has been raising the federal funds rate. (This is the rate that commercial banks are instructed to charge each other when they borrow and lend their excess cash reserves to each other overnight.) It should be remembered that this is the only interest rate that the Fed technically controls. I use the word “technically” because while this is 100% accurate, when the Fed raises this rate, all other interest/mortgage rates inevitably react in tune with the Fed’s decision. To be clear, when the Fed raises the federal funds rate, interest payments on everything from your credit card, auto loan, mortgage, etc. will be higher, going forward. Conversely, when the Fed lowers the federal funds rate, your rates will decline, going forward.
The Fed has been sharply raising rates in an effort to slow the economy, and, therefore, reverse the inflationary atmosphere we find ourselves in. When interest rates are high, people will spend less. And when demand falls, prices must fall as per the ironclad laws of supply and demand. It is widely believed that at the next Fed meeting in November, they will again raise rates by another 3/4 of a percent. (If true, this will be the fourth time in a row that the Fed will raise rates by this historically high amount.) This will further serve to boost mortgage rates again.
Yet another downside to the increase in rates is that builders are disincentivized due to increased borrowing costs. And when there is less supply, prices tend to climb.
And guess what? Due to higher mortgage rates and higher building costs, the Mortgage Bankers Association reports that mortgage applications have declined for the past four months, plunging to the lowest level since 1997 – 25 years ago. No surprise here.
The combination of higher mortgage rates and the limited supply of housing on the market (especially new housing), means affordability has dramatically declined. And, yes, according to the Commerce Department, housing starts, which measure the annualized change in the number of new residential buildings have tumbled. Specifically, housing starts dropped 8.1% in September. And home builder sentiment according to various metrics has fallen in October.
Further, the September employment report was stronger than expected, which shows that so far, the economy is weathering the rate hikes. And since the Fed wants to slow down the economy to tame inflation, high employment is a hinderance to that strategy. Why? Because high employment translates to people continuing to spend – pushing up inflation. The Fed actually wants to raise the unemployment rate to slow the inflationary spiral. To many people, this strategy seems counterproductive and cruel. But, in fact, the only way to tame the poison of inflation is to slow the economy – and that inevitably means higher unemployment.
In life, things are simple when the choices are clear between a good and bad option. But sometimes we are only offered two bad options. This is one of those times. If the Fed wants to reduce inflation, it must proceed with the tough medicine of continuing to raise rates. The short-term pain caused with these rate hikes is for the greater good in the medium and long term. Otherwise, inflation will be with us into the foreseeable future – long term pain.