By Susan Doktor
If you’re thinking about buying a home, nobody can blame you for feeling a little blue. Two economic factors are conspiring to make buying a home a lot more expensive right now. Finding the home of your dreams at a price you can afford is a dicey proposition these days.
The first factor is rising mortgage rates. After bottoming out at around 2.65% during 2020, the best mortgage rate for a thirty-year fixed rate home loan—the most popular mortgage type and term—was teetering around 5.3% in mid-May.
The second factor is the soaring home prices we’ve seen since the beginning of the global pandemic. In July 2021, real estate prices reached a crescendo, increasing by 19.1% when compared with pre-pandemic prices. Most analysts predict that home prices will continue to rise modestly over the next year. They won’t surge, perhaps. But every little bit hurts when you’re looking for the perfect home.
And that’s not all that’s in play in today’s housing market. Piling on top of homebuyers’ pain is the highest rate of inflation we’ve experienced in some 40 years. Across the board, from energy to electric cars, pet food to pistachio nuts, everything is more expensive now. Home buyers and sellers feel this particular pinch equally, of course. But when home sellers make improvements to their property, they pass that cost along to house seekers pretty much directly.
It may be of small consolation, but if you’re in the market for a new home, it may help to understand all three of these economic phenomena is happening right now. They’re all interdependent. And the reasons behind them can largely be boiled down to the basic economic law of supply and demand. When the supply of something exceeds the demand for it, the cost of the product is low. Here’s how supply and demand affected—and will continue to affect—the real estate market.
How Supply and Demand Affect Mortgage Rates
The beginning of the global pandemic ushered in a period of high unemployment. Workers who saw their jobs disappear or their hours greatly reduced were having a tremendously hard time making ends meet. Many maxed out their credit cards just buying the basics. Facing a suffering population and a completely uncertain economy, the federal government took steps to prevent a social and economic collapse. One of those steps was to significantly lower the federal funds rate. That’s the rate that one financial institution pays to another to borrow money in the short term and it affects consumer borrowing in all kinds of ways. Because banks could borrow money for less, they were able to offer mortgages at the record-low rates we saw in 2020 and 2021. The supply of credit was high and the price of credit was correspondingly low during that period.
Another economic factor also raised interest rates. Banks typically invest money in treasury notes—particularly the 10-year variety. They’re considered a very low-risk investment—certainly less risky than loaning money to home buyers. In the first years of the global pandemic, the yield offered by T-notes sunk to 1.01%, and they became a less attractive investment for banks than loaning money to consumers. Today, the reverse is true. T-note yields are more than double now. They reached 2.8% in December 2022. Suddenly t-notes are a more attractive investment again. Financial institutions are back to investing in them—unless they can earn more by loaning money to home buyers. They can earn more by lending to homebuyers and charging higher interest rates than the t-note yield. That’s another reason we’re seeing mortgage rates creep up this year.
How Supply and Demand Affect Home Prices
In most communities across the nation, the supply of homes for sale is outpacing the demand for them. The low inventory of homes for sale can be traced back to two causes. At the beginning of the global pandemic, many homeowners who might have otherwise sold their homes decided to stay put. They were hesitant to sell their homes, facing an unpredictable economy. As the pandemic wore on and working from home became the norm, employees realized that they could get paid to work from anywhere. Many decided to finally take the plunge and move where they’ve always wanted to. They had multiple reasons: to be closer to family, to give their kids the benefit of a better school system, or even to do their jobs from a waterfront property. Labor experts predict that the work-from-home revolution is here to stay. The incentive to relocate to a more attractive home persists and the inventory of homes for sale remains low. Home prices continue to increase: the law of supply and demand is immutable.
How Supply and Demand Affect Inflation
Fast forward to 2022. The economy is thriving in some respects. Businesses that had temporarily shut down or cut their staff have reopened and they’re hiring. Unemployment is lower than it has been in years.
Many employers are having a hard time filling their open positions, during what has been called “the Great Attrition.” Surprisingly, considering the state of the economy just a few months ago, employees are quitting their jobs in large numbers—some 19 million of them since April 2021. Not surprisingly, wages have increased—modestly in some sectors and aggressively in others, such as the tech industry as the job market has become more competitive. That’s supply and demand at work again. When the supply of workers is low, it costs more to hire them.
When the cost of labor increases, businesses pass on their expenses to consumers and raise prices. That’s one of several causes of inflation. Another is the disrupted supply chain precipitated by the pandemic. Remember the panic-driven rush to buy toilet paper? Retailers had a hard time keeping their shelves full of even the most basic products. You’ve probably noticed how some brands you were accustomed to buying have disappeared from stores. Low supply and high demand are other reasons the cost of goods continues to rise. To be fair, some consumers believe that inflation is caused by corporate greed and price gouging.
The Government is Taking Steps to Control Inflation
Remember the dip in the federal funds rate and how it increased the demand for credit? To put the brakes on inflation, the Federal Reserve Bank has now sharply raised the rate again. That means borrowing money is more expensive, whether to buy a home, take out an auto loan, or make credit card purchases. The theory is that if borrowing money is more expensive, that will cause people to buy less. When people stop buying, demand for products will decrease and, with it, the cost of goods. That won’t happen overnight, but hope is on the horizon. The inflation rate appears to have peaked in March 2022, when it reached an astonishing 8.5%.
Is It Smart to Buy a Home Right Now?
That’s a personal decision. But here’s what you need to know right now:
- Home prices will continue to increase. Real estate has always been considered one of the safer investments you can make. Over the past ten years the cost of housing has steadily increased by more than 48%. Even when real estate inventories are low, prices go up at least a little bit.
- Once inflation is under control, we might see a dip in mortgage rates. But it’s also possible that rates will continue to rise, in which case, locking in a lower rate now is a smart move. Should interest rates go down again, there’s always the option to refinance your mortgage.
- If you plan to sell your current home to purchase a new one, you’ll benefit from today’s ultra-high home prices. For people who plan to downsize, that presents an opportunity to put a lot of money in the bank.
To make sure you’re making the best move—the one that satisfies your wishes without straining your budget, call in a cadre of trusted professionals. A licensed Realtor® will typically be more educated than a real estate agent and vetted for his or her strong ethics. Find a great home inspector before you sign on the dotted line. And consider a wide range of mortgage lenders and mortgage options to secure your best mortgage rates. Hint: join a credit union! As not-for-profit lending institutions, they can often beat the rates offered by commercial banks and online lending companies.
Author Bio: Susan Doktor is a journalist and business strategist. She covers a wide range of personal finance topics in her work, including real estate, mortgages, and other financial services. Her contribution comes to us courtesy of Money.com.