Effects of Higher Interest Rates on Housing and Consumers

Chief Economist Eugenio J. Alemán discusses current economic conditions.

In our Weekly Economics Thoughts of the Week for last week, we showed that the housing market, i.e., real residential investment, had been one of the most impacted sectors by the increase in interest rates over the last several years with real residential investment declining for nine consecutive quarters, quarter-over-quarter, and then slightly recovering during the third quarter of last year, which is the latest available data. At the same time, the sales of homes, both new and existing, have continued to come down as the pool of potential homebuyers continues to shrink due to higher mortgage interest rates on home purchases. However, the increase in what American homeowners must pay on their mortgage, that is, the effects of the effective rate of interest on mortgage debt outstanding has been relatively small, as shown in the graph below, due to the characteristics of the U.S. fixed rate mortgage market.

Effective Rate Of Interest on Mortgage Debt Remains Low

Although 30-year fixed mortgage rates have almost doubled since the Federal Reserve (Fed) started its tightening campaign (and more than doubled from their lows in 2020), the effects over the level of the effective rate on mortgage debt outstanding have increased by just 13%. At the same time, we have not seen a buildup in dubious mortgages being sold right and left by unscrupulous mortgage lenders due to the guardrails built after the Great Recession. That has prevented the mortgage industry from relying on the mortgage products that gave rise to the housing market collapse of 2009-2010. Furthermore, the negative impact on Americans’ ability to pay their mortgages has been minimal. Only those who have the income to buy new or existing homes at current prices as well as at current mortgage rates have been buying homes while those who had mortgages before the increase in rates have suffered no increase in mortgage payments over the last two years.

This is very clear by looking at the graph below, where we plot the mortgage debt service ratio, that is, mortgage debt service payments as a percentage of disposable personal income, which has remained at historically low levels and continues to show very little effect of higher mortgage interest rates on American families.

Mortgage Debt Service Ratio