Past as Prologue: How Rising Rates Affect the Industry

Jobs. The economy. Avocado toast. There are plenty of topics that Baby Boomers and Millennials fight about these days. The two largest generations – accounting for 145 million people in this country as of 2016, according to the U.S. Census Bureau – often find themselves at odds with one another. And one thing they fight about, loudly, is homeownership. Boomers complain that Millennials are too lazy to enter the housing market, while Millennials counter that house prices are too high. Boomers say that Millennials can't save. Millennials argue that Boomers didn't have to.

"Yeah, but back in my day, my interest rate was 18 percent."

Wait, that can't be right, can it?

It's true. Between 1977 and 1981, the interest rate for a new 30-year fixed-rate mortgage rose from eight percent to a staggering 18 percent. It was the most dramatic increase in mortgage rates in the last 50 years. The effect on the housing market during that time was huge. Mortgage originations fell nearly 40 percent, home sales dropped 36 percent and housing construction was cut in half.

And you know who was right in the middle of that chaos? Baby Boomers.

In 1981, Boomers were between the ages of 17-33. According to the National Association of Realtors' Profile of Home Buyers and Sellers, the median age for first-time homebuyers in 1981 was 29. The Boomers are right – when they were first leaving their parents' houses and striking out on their own, many had to deal with the largest interest rate hikes in modern U.S. history. (Let's ignore the fact that the median home price was just a shade above $100,000 during that time).

The good news is that since then, mortgage rates have mostly trended downward. In fact, despite the recent uptick in rates to begin 2018, mortgage rates have been historically low – the 30-year fixed mortgage rate was at 4.44 percent as of March 15, 2018, almost a quarter of what it was in 1981.

But what if rates continue to trend higher? To analyze the potential effects, in our February Insight, my colleagues looked at times when rates increased by at least a full percentage point over the course of at least eight months. This has happened six times since the highs of the early 80s. In historical episodes of rising rates, home sales slipped, housing starts stalled, and mortgage originations swooned.

What is going to happen to Millennials, who are currently between the ages of 22 and 37, if they try to buy a house this spring? With rates up a quarter percentage point from a year ago and potentially headed higher, it's going to be tough for them. It is simple math: The higher the mortgage rate, the higher the monthly payments required to purchase a home. This causes many first-time home buyers to either choose a lower-price home—and good luck finding one with today's tight for-sale inventory—or continue to rent while waiting for a better market.

That decision to not buy ripples across the industry, having a negative effect on mortgage lenders, real estate agents and home builders – many of whom are, you guessed it, Baby Boomers. The youngest Boomers are currently in their mid-50s. Those Boomers still in the industry, maybe even getting ready to retire, would feel the adverse effect if Millennials decided not to buy en masse.

When we crunched the numbers of how the housing market responded to higher mortgage rates since 1990, we found that on average following periods of rising rates:

• Home sales dropped 5 percentage points;
• Housing starts fell 11 percentage points; and
• Mortgage originations fell 30 percentage points.

Do recent rate increases mean housing markets will contract this year? It's too early to tell for sure, but early indications from the latest Mortgage Bankers Association's Weekly Mortgage Applications Survey shows demand is holding up, with purchase mortgage applications up three percentage points from a year ago. As we said in our February Outlook, if job growth remains robust and incomes start rising, there's enough pent-up demand that housing markets could post modest growth this year. That would make 2018 the best year for housing since...last year.

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