Investors have been so focused on how the Fed’s dovish stance on interest rates led to a rebound in stock prices that they haven’t yet digested how much this development could stimulate the housing market, particularly in the back half of the year. Friday’s strong numbers on existing home sales – up nearly 12 percent last month compared to January – might get their attention.
With the decline in interest rates over the past three months, the housing market now has three tailwinds all lined up for the first time in this cycle. The first is demographics. After declining for 12 years from 2004 through 2016, the homeownership rate has been increasing ever since, as the hangover from the housing bust wears off and the job market has improved to the point where workers are buying houses again. This is particularly true for younger households, who largely couldn’t or wouldn’t buy houses in the years after the housing bust. The biggest birth cohorts of the millennial generation were born between the late 1980s and early 1990s, and they’re now entering their 30s, prime home-buying years. Entry-level housing demand should be robust for years as these buyers start to shift from renting to owning.
The second is the labor market. On just about any measure -- from the unemployment rate, labor market sentiment, the percentage of prime-age people who are employed, and increasingly wage growth -- the labor market is as good as it’s been in a generation. As mortgage underwriting standards have tightened following the mortgage fraud in the last cycle, this is particularly important. Given the high employment rate of recent years, a growing number of Americans have solid income history to qualify for a mortgage.
And the third, thanks to the recent drop in interest rates, is affordability. The 10-year Treasury rate has fallen around 0.7 percent from its highs in October and November. Mortgage rates have followed suit. Last autumn there were fears that the rise in interest rates would take 30-year fixed-rate mortgages above 5 percent, but after the recent drop in rates we might be talking about mortgage rates below 4 percent pretty soon. On a $300,000 house with a 20 percent down payment, a one percentage point drop in mortgage rates would reduce a monthly payment by around $140 per month.
There are a couple other reasons the decline in interest rates could lead to a housing-related economic boost. Anyone who bought a house and took out a mortgage when mortgage rates peaked in the fall will become eligible to refinance their mortgage over the next couple months. This could make it advantageous for hundreds of billions of dollars’ worth of mortgages to refinance, meaning new fees for bankers and cost savings for homeowners. Additionally, given the rise in home values that has gone on for years now, homeowners increasingly have home equity they can tap, which they are increasingly choosing to do. This doesn’t mean homeowners will get crazy buying boats and vacations with home equity the way some might having during the peak of the housing boom, but it represents another pool of wealth for households to tap.
If people are looking for a comparison to the last cycle, they shouldn’t think about the later years of the boom, but perhaps the earlier ones. The busting of the dot-com boom led to a large decline in interest rates and an economic growth handoff from the tech sector to housing. While we probably aren’t looking at a shift as extreme as that, people worried about a slowdown in overall economic growth should think about the boost that lower rates could give to the housing market.