The Expert Podcast

The new construction home market has been the last thing holding up the real estate sales industry for about the last year and a half. The resale home inventory availability has been struggling. Nobody wants to sell their existing home and get rid of their three or four percent mortgage rate, so new homes are really the only place that new inventory has been coming out to the market. But there are some cracks in the armor. New home sales have fallen 8.7 percent in August, so it's starting to show that even new homes are being affected by the interest rate.

Interest rates now have climbed to really near eight percent, and it's very likely that they're going to be at 10 percent relatively soon, within the next year and a half or two years. Matter of fact, we predict that by 2025, maybe the end of 2024, you'll see double-digit mortgage rates at 10 percent. Why is that? Well, a lot of people think that rates are high now because they're in the seven percent range. Historically, seven percent is actually a pretty good rate.

If you go back 20 or 30 years, most of the time, the rates were in the seven or eight percent range. The reason that they're going to go above this profile is because the Federal Reserve has now announced that the current rate level is what they call the natural rate—5.5 to 6 percent on the Federal Reserve rate, which isn't the mortgage rate, but what the Federal Reserve sells money for. This is considered to be natural. What does that mean for mortgage rates? Well, over the next year and a half, the Federal Reserve is going to see that inflation is still creeping up, so they're going to have to bump their rate up above the natural rate.

Mortgage companies have to mark that rate up to make a profit. So if the natural rate is 5.5 or 6 percent, they have to bump it up a few percentage points to basically run their business normally. The mortgage companies have to bump that rate up by 1.5 percent, maybe 2 percent, or even 2.5 percent in some cases to make a profit. But because of the fact that mortgage volume is down so dramatically and the risk is higher, they’re going to have to bump that rate up maybe 3.5 to 4 percent. So do the math: if the Federal Reserve rate is around 6 and the mortgage companies have to bump it up 4 percent to make a profit, now you're at 10 percent.

A 10 percent mortgage rate isn't low, but there have been many times in the market that mortgage rates have been in the double digits. Back in the 80s, mortgage rates were 12, 14, even 18 percent for a brief period of time. One thing about the 80s that's similar to today is that you would be coming off a period in the late 70s and early 80s of high inflation and high gas prices. Does that sound familiar? The government had to keep these rates high, and the other alternatives to saving money were in that higher rate range.

Think about it: you can go to a bank right now and find banks offering CDs at 6 percent. So if you have money to play somewhere, why put it in a mortgage at 7 or 8 percent, which has risks—somebody could default, there could be fees—or put it in a CD at 6 percent? That's why mortgages will likely go up around 10 percent within the next year and a half or two years. That will affect the housing market even more because fewer people are going to sell their homes, and there'll be fewer buyers for new homes.

There’s also another troubling statistic that a lot of people didn’t realize: even as rates went up, new home purchases still went up a little bit overall—like 2 percent. They didn’t go up that much, but still, people are buying new homes, both resale and new homes. But you would think that refinances would fall, right? Why would anybody refinance when the rate is 7 percent or 6.5 percent? Well, in the second quarter of 2023, refinances actually went up. The number of refinances jumped.

Why is that? Well, nobody who refinanced had a rate lower than 6.5 percent. I’m sorry, nobody had a rate higher than 6.5 percent, so everybody that refinanced at 6.5 or 7 percent was refinancing from a lower rate. Why would you go from a lower rate of 3, 4, or 5 percent to a higher rate? There's only one reason anybody would do that. Can you guess? In case you didn’t figure it out, it's because they needed to cash out.

Why would refinances go up in a high-rate environment unless people needed to take cash from their house? That’s a troubling sign. It means that people are starting to run out of money and have to pull out money from their house, even if it's going to cost them higher on the interest rate. I know you have an opinion about that. Let us know in the comments what you think.