Do Rising Interest Rates Price Out Mortgage-Ready Borrowers?
Mortgage rates have risen quickly in the past year, putting many mortgage-ready potential homebuyers on hold. As rates rise, according to recent Freddie Mac analysis, the pool of homebuyers who would qualify for the current average loan decreases notably — by around 15 million.
Mortgage rates have increased at the fastest rate since the early 1980s. According to Freddie Mac’s Primary Mortgage Market Survey®, rates increased from slightly more than 3% in early 2022 to more than 7% as of early November. While these rates are not as high as they were in the 1980s, they have more than doubled in the past year. Mortgage rates have never doubled in a year before.
This high-rate environment has pushed market confidence down. According to Freddie Mac’s latest housing outlook pulse survey, 19% are likely to buy a home in the next six months, a 5 percentage point decrease from the second quarter. Freddie Mac also forecasts annual home sales to decline from 7 million in 2021 to 5 million in 2023, a decline of approximately 30%.
But at what point do higher rates become too high for consumers? A recent Freddie Mac analysis sought to answer that question.
Finding Mortgage-Ready Homebuyers
Using anonymized credit bureau data, Freddie Mac analysts created estimates enumerating the number of mortgage-ready potential homebuyers with good credit that were priced out of qualifying for a mortgage due to higher mortgages rates. Higher home prices over the past two years have also decreased the pool of mortgage-ready potential homebuyers by as much as 42%.
“Mortgage rates have doubled in the last year and as a result, the population of mortgage-ready potential borrowers has fallen significantly,” said Ralph DeFranco, macro housing economics senior director at Freddie Mac.
Mortgage-ready potential homebuyers are defined as those who:
- Do not have a mortgage.
- Have a credit score of 661 or above.
- Have no foreclosures or bankruptcies in the past 84 months and have no severe delinquencies in the past 12 months.
- Are 45 years-old or younger and have an estimated backend debt-to-income ratio less than 25%.
Our researchers determined the total number of mortgage-ready potential homebuyers who had the capacity to afford mortgages ranging from $200,000 to $600,000, with interest rates ranging from 3% to 8%. Mortgage capacity is defined as the maximum house price a mortgage-ready consumer can afford, given his or her income and debt, assuming a 3% down payment, a 30-year fixed-rate mortgage and a debt-to-income rate of 43%.
For example, the pool of mortgage-ready potential homebuyers that our analysts estimate would qualify for a $400,000 30-year fixed-rate mortgage at a 3% interest rate was approximately 26 million people.
How Interest Rate Changes Affect Mortgage-Ready Borrowers
As interest rates increase, the population of mortgage-ready potential borrowers falls.
The following chart illustrates how mortgage capacity decreases as interest rates rise.
Source: Freddie Mac
For instance, the pool of mortgage-ready potential homebuyers who have the capacity to afford a $400,000 loan declines significantly based on the available interest rate. This is important, as the nationwide median home sale price for existing homes was $384,500 in September; for new homes, it was $470,600.
While 26 million mortgage-ready potential homebuyers had the capacity to afford a $400,000 mortgage at a 3% interest rate, the total falls by 3 to 4 million with each percentage gain.
- 4%: 22 million homebuyers.
- 5%: 18 million homebuyers.
- 6%: 15 million homebuyers.
- 7%: 12 million homebuyers.
- 8%: 9 million homebuyers.
Based on the recent high mortgage rate, near 7%, and median home prices, approximately $400,000, only 12 million mortgage-ready potential homebuyers have the capacity to afford mortgages, compared to 26 million when rates were 3%. This means over the past year, around 15 million potential homebuyers may have been priced out.
For more insights from Freddie Mac’s research team, visit Research Insights, Notes & Briefs.