Mortgage rates above 7% have put the housing market on ice as affordability challenges put off a lot of buyers. Newer, younger homeowners who locked in their mortgage at a low interest rate — and whose next move probably would be trading up — are content to stay where they are until mortgage rates fall.
But there's one group of homeowners for whom high interest rates are arguably good news as they contemplate their next housing market transaction: downsizing members of the baby boom generation. For them, housing and financial market conditions are more attractive than a year ago.
Consider a homeowner in their 60s who has recently retired or is planning to retire soon, and who is contemplating a move. That housing-market transaction might be selling a four- to five-bedroom house for something smaller and more manageable, or moving from a high-cost state like New York or California to a lower-cost state like Florida or Arizona (or both). Their new house will be cheaper than their current house, meaning they'll get cash out of this transaction — potentially hundreds of thousands of dollars.
That's in part because of how older homeowners differ from younger homeowners. While the average home price in the US is around $400,000, it stands to reason that older homeowners have on average more valuable homes than younger homeowners who only recently bought into the market. And older homeowners in many cases benefit from decades of home-price appreciation. They're also more likely to have paid off their home in full, or have mortgages that are relatively small compared with the level of equity in their homes.
If someone sells a fully paid-off home for $800,000 and buys a cheaper retirement home for $500,000, they're not giving up a low mortgage rate because they don't even have a mortgage, and since they're paying all cash they don't care about whether mortgage rates are 7% or more. With the surge in interest rates this year there's actually a decent yield they can earn on the extra home equity garnered from the transaction, which wasn't the case through most of the prior decade. With 10-year Treasury yields around 4%, it's possible to buy relatively low-risk investment-grade corporate bonds yielding 5%-6%. If more income is needed in retirement, it wouldn't matter that much if interest rates continue to rise — they can rely on that interest income regardless of where bond prices go from here.
It's true that home prices are now falling in most of the country, but outside of a few markets that boomed the most during the pandemic, prices are still up on a year-over-year basis. The S&P/Case-Shiller US National Home Price Index was up 9% year-to-date through July, and more real-time data from Redfin suggests that asking prices and sales prices are still close to that on a year-over-year basis. Meanwhile, the Vanguard Intermediate-Term Corporate Bond ETF is down 20% over the past year, with longer-term bonds and stocks down more than that. In a way, choosing to downsize now and invest the proceeds into financial assets is playing a sort of arbitrage that's occurred between the housing market and financial markets over the past year.
The situation we find ourselves in right now — with home prices still up meaningfully over the past few years while bond prices are down substantially given the rise in interest rates — is decidedly not what happened in the aftermath of the 2008 financial crisis. Then, home prices plunged, crushing the equity balances of older homeowners, and interest rates plunged as well in response to the Federal Reserve's rate cuts. The economics of downsizing are far more attractive in late 2022 than they were between the late 2000s and early 2010s.
I'm skeptical that changes in the prices of houses and interest rates will lead to a surge in opportunistic downsizing over the next year because homes are emotional assets as much as financial ones for many homeowners. If I'm wrong and there's suddenly a glut of larger, expensive homes hitting the market with few younger buyers interested, prices may fall significantly from where they are currently, reducing the attractiveness of the downsizing decision.
But if you're already considering downsizing, or you have parents who find themselves in this situation, you should be encouraged — higher interest rates might be causing a lot of pain for some, but for someone thinking about trading down, current conditions help more than they hurt.
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