Rising Interest Rates: Is It Time To Sound The Alarm? A Look at the Forces in the COVID-Market

Even without the global pandemic, the ensuing recession and the declining job economy, we might have found ourselves sounding the alarm for rising interest rates this quarter. What goes down, after all, must come back up. We started this new year with an average interest rate of 2.65% on a 30-year, fixed-rate mortgage. That marks a record low across almost 50 years in the market.
job economy in the post COVID-19 market

Along with that, high demand and low inventory have made for an incredibly competitive market, creating the head-turning effect of rising home prices throughout the pandemic. Charted against the decline in rental prices, the housing market doesn’t seem to make much sense. Nonetheless, residential real estate has performed well through COVID-19.

The short-term future, however, might not be quite as bright—it certainly won’t be a straight, upward line. 

Rising Interest Rates —Factors at Play

Most investors have seen this market movie before. Since the financial crisis in 2008, interest rates have hovered at historically low levels. The COVID-19 pandemic has prompted a governmental response that history hasn’t seen since the second world war. Stimulus measures and support strategies embraced across the globe are leading to a fiscal expansion, one that triggers the fear of heightened interest rates.

And while this is more a fear than a reality, the increase in treasury yields was a headline-making event; higher treasury yields signal higher interest rates. Still, this is more of a temperature check than a prescription, and investors need more information before they understand how increased treasury yields, and the threat of rising interest rates, will impact mortgage rates. 

Finding the Full Story

Treasury yields have a directional relationship with mortgage rates, and they’re often used as a proxy. They’re also understood as an indicator of investor confidence and sentiment around the economy. When we watch treasury yields for their mortgage rate implications, the recent rise does matter—especially because it’s happened quite quickly. But what also matters is the rate from which the yields are rising.

A recent report, by the experts at UBS, graphs the changes in treasury yields against mortgage rates and helps to expand on the real ramifications. They illustrate first that treasury yields are coming off of historically low levels. While this still puts upward pressure on mortgage rates, the effect is diminished because there’s still a wide spread between the two trends. In other words, treasury rates are rising, but they’re staying below their average level, maintaining a healthy spread. 

30 year fixed rate mortgage trends - housing interest rates trend

There are also more factors affecting mortgage rates, making the relationship with treasury yields non-linear. Regulatory policy, lending policy, market initiatives, market demand, mortgage refinancing, and the availability of alternative products and lenders; these are just some of the realities to add to the equation. 

Post-COVID Housing: A Short-Term Outlook

At least as important as the movement of mortgage rates is their absolute value. If a prospective homebuyer browsed the market today, they could expect a 30-year fixed mortgage rate at roughly 3.25%. That’s a low base rate, and it means they have some room to manage a slight increase in mortgage rates.
monthly payment sensitivity to rising mortgage rates new home
monthly payment sensitivity to rising mortgage rates existing home

In fact, the median homebuyer can withstand a certain movement in rates without seeing too much of a financial impact. Experts at UBS predict this window to be roughly 75-100 basis points, charting the impact of higher mortgage rates on monthly payment sensitivity. According to their data, a 75 basis point increase would translate to an incremental monthly payment of an existing home of roughly $117 USD. With further calculations of median homebuyer income, that would translate to approximately 2% of their monthly household income. For a new house, those numbers would be $149 USD and 2.5%, respectively. 

High Rates, High Hopes?

By way of a small silver lining, there could be long-term benefits to a gradual and continual increase in mortgage rates across the housing sector. This would have the effect of slowing the pace of home appreciation, which UBS experts consider a positive for the long-term health of the housing market. Higher mortgage rates can, after all, have a positive effect on rental real estate; the market for properties increases, and prices can reduce.

In short, it’s never quite as simple as the headlines make it seem. The chances of entering a high inflationary period after COVID-19 seem too high to discount, and the recent uptick in treasury yields forebodes some change in mortgage rates. But coming from record lows, there’s still a long way to go before the ripple effects are felt throughout the housing market. 

Further, there’s reason to believe that a gradual, sustained increase could do more good than harm to the industry as a whole. Similar developments will surely make headlines as we all face the task of recovering from the economic shock and re-planning for the post-COVID market. But it’s rarely as simple as the stories make it seem, and in all likelihood, we have more room than we might think.