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Raising Rates Can Be Good For The Housing Market

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POST WRITTEN BY
Mark Fleming
This article is more than 8 years old.

The Federal Reserve made waves by recently dropping the word “patient” from its outlook on interest rates. This simple, one-word change, indicates that the Federal Reserve could soon raise rates—which have been stuck at near-zero for over six years—as early as June. Once this happens, rates on everything else will increase with it.

But here’s the question: What effect will an interest rate hike have on America’s housing market?

Few questions are as important coming out of the Great Recession. Housing, after all, was one of the hardest-hit areas of the economy following the financial collapse in 2007. Foreclosure rates in 2008 hit nearly hit nearly 2% of all available housing units—an 81% increase over 2007 and a 225% increase over 2006. The collapse of the housing market and its ripple effects led the Federal Reserve to lower interest rates, in part to ensure that the country’s housing market did not completely crumble.

This is why some housing market experts are now sounding the alarm about an interest rate hike: The conventional wisdom holds that the housing market suffers when rates rise, causing affordability to drop. The chief economist at the National Association of Realtors put it best, recently arguing, “With all indications pointing to a rate increase from the Federal Reserve this year – perhaps as early as this summer – affordability concerns could heighten as home prices and rents both continue to exceed wages.”

Housing market isn't as weak as most experts claim

But the conventional wisdom is wrong for two reasons. First, the housing market isn’t nearly as weak as most experts claim it is.The foreclosure rate has dropped rapidly since its peak. Last year, it fell it fell 8% to a total rate of 0.07%—a rate of 1 in every 1,295. At the low end, North Dakota has a rate of 1 foreclosure in every 64,942 housing units, for a total foreclosure rate of 0.001%. Even in last place Maryland, where the foreclosure rate is 0.17%, the situation is significantly better than it was six years ago. The legacy of housing distress is quickly disappearing.

More generally, the housing market is forging ahead on the strength of an improving economy. Just look at the last year. Between February 2014 and February 2015, the number of new homes sold rose by rose by 24.8%. Existing-home sales were up were up 4.7% over the same period. Best of all, the median existing-home price was nearly $203,000 in February 2015—more than 7% higher than it was the year before.

Put another way, the housing market is healthier than it has been at any point in recent memory. There is no better time for the Federal Reserve to end this unprecedented period of low interest rates.

 A rate hike means the rest of the economy is doing well

The second reason is ultimately more important. Any dip in the housing market will likely be offset by gains in other areas of the economy. Housing experts are right that rising rates crimp housing affordability and therefore slow demand. What they miss, however, is that a rate hike signifies that the rest of the economy is doing well. The housing market should not be seen in a vacuum—it must be viewed in the context of the larger economic recovery.

The Federal Reserve is well aware of this. It will only begin raising rates as unemployment falls and wages begin to rise. Yes, this will act as a headwind that buffets the housing market. At the same time, however, the housing market will benefit from the tailwind of increased job certainty and rising wages.

In fact, that tailwind could be so strong that it overcomes any negative effects from a rate hike.

This isn’t baseless speculation. The Fed itself predicts that 2015 will see unemployment drop to drop to 5.2%. Meanwhile, disposable personal income is expected to grow by 4.1%, according to Fannie Mae—the largest annual increase since before the Great Recession.

Mortgage rates could settle at 4%

What does this mean for the housing market? A lot. Fannie Mae’s economic forecast for 2015 estimates that rates will rise by 30 basis points—or 0.3%—by the end of this year. When this is combined with the Federal Reserve’s economic predictions, it means that mortgage rates this year could settle at 4% for a 30-year fixed rate mortgage. At this rate, total home sales in 2015 would likely increase by roughly 5.2%—a far cry from the 2.6% decline in 2014.

In other words, a reasonable rate hike will not be the death knell for America’s housing market. It merely reflects strong economic growth, which could make the housing market even more competitive than it is today. The Federal Reserve would do well to remember this—and to ignore the alarms currently coming from too many in the real estate industry—as it weighs when to increase rates. The housing market, like the rest of the economy, will not only survive—it will also thrive.

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