If you’re feeling frustrated about buying a house right now, you’re definitely not the only one. The Federal Reserve Bank of Atlanta has reported that home affordability is nearing record lows. A troubling mix of soaring home prices and high-interest rates has wreaked havoc on the housing market. Unfortunately, simply lowering interest rates won’t fix the underlying issues.
To grasp the roots of this affordability crisis, it’s essential to recognize what’s been happening over the past few years. The federal government has spent trillions of dollars, which, although massive, isn’t the whole story. The Federal Reserve played a big role too, creating trillions from nothing and effectively driving interest rates down.
The real solution? I think it involves letting interest rates fall naturally instead of trying to force them lower through government intervention.
This situation led to a rapid depreciation of the dollar, which has resulted in the highest inflation rate seen in 40 years. As inflation peaked, interest rates climbed rapidly as well.
Costs are rising
Home prices have skyrocketed compared to income levels, making it tough for many. During the Biden administration, monthly mortgage payments have doubled for the median home price.
This has tightened affordability for countless Americans. The artificially low-interest rates initially helped inflate home prices, not only because the dollar has depreciated—but also because buyers were encouraged to spend more as they could afford larger loans thanks to lower rates.
When thinking about purchasing a home, the primary concern for many is the monthly mortgage payment, not just the home’s sale price. These payments depend on the overall price and, crucially, on the interest rates. When rates dipped below 3%, it allowed buyers to stretch their budgets a bit more without a huge change to their monthly payments.
But as time went on, bidding wars continued to drive prices up. Then, when interest rates normalized again, it turned everything upside down, with monthly payments soaring. Today, these payments can consume over two-thirds of a median household’s income just to secure a median-priced home.
Historically, rising interest rates would lead to a drop in home prices, but this time it’s different. Many homeowners are locked into mortgages with rates below 4%—some even below 3%—making it hard for them to sell their homes.
To navigate these waters, sellers would need to command higher premiums to make hefty down payments on their next purchases, thereby reducing the amount they need to borrow at current higher rates, thus keeping monthly payments manageable. This spike in interest rates has driven prices higher, not lower.
Let’s not impede progress
Currently, there’s a strong temptation to have the Fed lower its federal funding rate, thinking that it will bring interest rates down across the board, including for mortgages. The sad truth is that doing this may worsen the already struggling housing market.
Last fall, a questionable move—perhaps perceived as election interference—saw federal rates drop without substantial empirical backing. While this action seemed to support stock prices temporarily, the reality was that artificially low rates led to more inflation, which ultimately caused higher rates in the private market.
Inflation is not favorable for lenders; it erodes the future value of the repayments they expect to receive. Consequently, lenders demand higher returns. For instance, at the end of last year, Treasury debt yields surged significantly after federal rates were cut.
There’s a connection between interest rates and home prices. If rates decrease by a point or two, it could encourage buyers to borrow more, driving prices up yet again. Unless we see substantial drops in rates, homeowners will likely stay stuck with their favorable rates, unable to move.
Instead of manipulating rates further, the emphasis should be on reducing government spending, which would diminish demand for borrowed money. Lower demand could lead to lower prices, including for loans themselves.
In summary, government spending has significantly damaged the housing market, and only fiscal restraint at the federal level can resolve this ongoing issue.
