Wharton’s Benjamin Keys speaks with Wharton Business Daily on SiriusXM about the impact of higher mortgage interest rates on home buyers.

The recent uptick in mortgage interest rates is having a chilling effect on home buyers at the moment, but Wharton real estate professor Benjamin Keys doesn’t expect that to last.

Sky-high rents have been spiraling faster than home prices in the last decade, which will continue to push many Americans toward home ownership. With a fixed-rate mortgage, they can budget a stable monthly housing expense for the next 15 or 30 years.

“What’s fascinating about the housing market right now is the forces of supply and demand seem to be out of whack,” Keys said during an interview with Wharton Business Daily on SiriusXM. “We are in a really unique housing market right now, where we have both interest rates rising and we have housing prices rising.”

Mortgage interest rates have increased across all categories in the last several weeks, following the Federal Reserve’s first rate hike since 2018 to fight inflation. The interest rate on a 30-year fixed-rate mortgage topped 5% last week, compared with less than 3% a year ago. The jump corresponded with a 40% drop in mortgage applications from a year ago.

“Aside from a few days in 2018, we haven’t seen rates this high persistently since around 2011,” Keys said. “Mortgage rates are the real focus among a lot of people right now, and trying to understand what impact [that is] going to have on housing markets.”

He said the rate hike immediately incentivizes current homeowners to stay put because they’re “locked in” to the great low rates they got over the last few years. It also “locks out” prospective homebuyers who now have to worry about higher interest rates adding hundreds of dollars a month to mortgage payments on homes that are already priced historically high. The median sale price of a home in the U.S. hit $405,000 in March for the first time ever.

“I think there’s a ton of uncertainty about where rates are going to head in the coming year.” –Benjamin Keys

Rates and Refi

The rate hike is also cooling off the red-hot refinancing market, evident in the reported layoffs in the mortgage industry. The professor said he’s waiting to see whether companies will get creative to make up the financial losses.

“The products that had teaser rates and option ARMs and all of the sort of scary monsters that we think of back during the financial crisis, those really grew out of a similar collapse in the refinancing market,” he said. “So, it will be interesting to see if lenders pivot to some of these more affordable products, especially in the face of high prices.”

Keys explained that the Fed bought mortgage-backed securities during the financial crisis and again during the COVID-19 pandemic to provide liquidity to the market when investors were skittish. But Federal Reserve Governor Lael Brainard indicated last week that the agency will begin reducing its portfolio of mortgage-backed securities because of the strong economic recovery. Keys said that announcement is also factoring into the higher mortgage interest rates.

Still, Keys noted, demand for housing is outstripping supply. In addition to rising rents and the scarcity of rental units, other demographics are contributing to the trend: a strong labor market, higher personal savings during the pandemic, and millennials who survived the Great Recession and are now financially ready to buy homes for their growing families.

“I think there’s a ton of uncertainty about where rates are going to head in the coming year,” he said. “We just have a very uncertain economy at the moment for so many reasons. We have the invasion of Ukraine. We have a variety of supply chain issues. We do still have a global pandemic going, and then we have this question of how the Fed is going to approach issues with inflation and how aggressive they’re going to be.”