Housing Affordability Remains Stretched Amid Higher Interest Rate Environment

IMF Blog, January 11, 2024

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Home prices have cooled relative to the start of the hiking cycle but remain above historical averages.
Home prices in advanced economies, including most European Union countries, as well as Africa and the Middle East are 10 percent to 25 percent higher than pre-pandemic levels.
Rising interest rates have passed swiftly to residential mortgage markets, impeding affordability for current and prospective home buyers.
Scarce home supply is limiting purchases in some regions, contributing to stretched affordability.

In the first half of 2023, mortgage rates in advanced economies climbed by more than 2 percentage points compared to the previous year.
Countries like Australia, Canada and New Zealand witnessed substantial declines in real house prices; in some advanced economies real house prices have fallen more than 15 percent.
On net, real house prices will need to keep cooling from the 2021 and 2022 highs to reach pre-pandemic levels.
Higher borrowing costs are likely to see the largest impact on household debt service ratios in countries where housing markets remain overvalued and average lifespans for mortgage loans are shorter (Global Financial Stability Report).

In advanced economies such as Norway, Sweden, Denmark, and the Netherlands with pre-existing double-digit households’ debt service ratios, borrowers’ debt servicing costs could increase by up to 1.8 percentage points given the surge in interest rates.
Increased debt servicing costs would affect loan approvals and borrower repayment capabilities.
Borrowers are also less indebted and underwriting standards have been strengthened since the global financial crisis, tempering the risk of a surge in loan defaults.
Stronger underwriting and lower leverage may have limited forced selling or foreclosures, helping to support home prices.

The Federal Reserve’s interest rate hikes pushed average rates on a 30-year fixed mortgage to a two-decade high of 7.8 percent.
Required down payments and reduced savings since the pandemic are putting homeownership further out of reach for prospective buyers.
Existing homeowners deterred by larger monthly mortgage payments are staying put, reducing the supply of existing homes (the “lock-in” effect), particularly in the United States where long-tenured fixed-rate mortgages are most popular.
Average 30-year mortgage rates currently at 6.6 percent, around 3 percentage points above pandemic lows.
Mortgage originations remain 18 percent below last year’s levels while refinancing applications increased 8.5 percent over the year as mortgage rates continued to ease.
The 30-year fixed-rate mortgages accounted for 90 percent of new US home loans at the end of last year (ICE Mortgage Technology).
Almost two-fifths of all US mortgages were originated in 2020 or 2021.

Higher interest rates also raise rental costs, reinforcing demand for renting over buying given slow adjustment of median house prices.
The combination of higher rates and still-scarce housing supply creates a vicious circle that complicates central banks’ fight against inflation.
US monthly home prices continued to rise in October compared with a year ago, with shelter contributing to one-third of the change of consumer prices in November.

If the Fed starts rate cuts this year, as policymakers and market participants project, mortgage rates will continue to adjust and pent-up housing demand could be unleashed.
A sudden increase in demand driven by rapid rate cuts could offset any improvements in housing supply and cause prices to rebound.

Monitoring household debt service ratios is critical in countries with overvalued housing markets and shorter-average mortgage lifespans due to potential increases in borrower stress.
Maintaining or reinforcing prudent underwriting standards can temper the risk of loan defaults and limit forced sales that would further depress prices.
Managing the timing and pace of monetary easing may be important to avoid triggering a rapid rebound in housing demand that would counteract supply-side improvements.

Source: IMF blog post "Housing Affordability Remains Stretched Amid Higher Interest Rate Environment", January 11, 2024.