The United States economy will enter 2017 in a rate-rising environment.
The recent December short-term rate hike is only the first of six to eight additional rounds of increases over the next two years. The head fake of hinting at, but not actually raising rates, will no longer work.
In the past, new developments, like an oil price collapse, government shutdown, the Greek bailout, or Brexit, provided cover for delaying the rate increases. Now, however, the Fed’s principal area of oversight — inflation — is on the verge of rapid acceleration.
Consumer price inflation hit 1.7 percent in November after clocking in at essentially zero in 2015. Core inflation, which excludes the volatile changes in food and energy prices, has been rising above the 2 percent mark for the past 12 months and could go even higher — possibly 3 percent in 2017.
That rise could happen, in part, because housing costs are soaring from multiple years of low housing starts. Not only are home prices outpacing people’s income, but the rent growth of 3.9 percent in November is the highest gain since early 2008.
The high-rent trend will continue due to historically-low apartment vacancy rates, and the very few homes on the market for sale. Unless gasoline prices crash to around $1 per gallon, which is highly unlikely, higher inflation will be with us over the coming years. That is why the Fed has to raise rates.
Consequently, the 30-year, fixed-rate mortgage is projected to be around 4.5-5 percent by the end of 2017. That’s certainly higher than the sub-4 percent rate of most of the past five years, yet it is nowhere near alarming by any historical gauge.
The last time mortgage rates hit 4.5 percent was for few months back in 2013 and home sales fell by 10 percent. Once rates fell back below 4 percent, home sales resumed their upward trend.
This time, the impact for rising rates could well be minimal. For one, the economy is in much better shape, with 7 million more jobs compared to 2013 and wage growth showing signs of impending acceleration.
A second neutralizing factor could be an expansion of the mortgage credit box. Homeowners are not defaulting, which is creating a natural incentive for lenders to loosen up.
The large profits of Fannie Mae and Freddie Mac, along with a much sturdier Federal Housing Administration reserve fund, are testaments to significantly improving loan performance trends. If underwriting standards were to return to normal from the current, overly-stringent conditions, an additional 10 percent of mortgages could be approved.
Another factor to help housing demand is the fact that adult children are leaving their parents’ basements. There are currently 15 million not-so-young adults aged 26-to-35 living with their parents, compared to just 10 million a decade ago. Surely it is not their idea of happiness to be so physically close to their parents at that age.
Such a situation is understandable during economic difficulties, but less likely as economic opportunities expand, as evidenced by continuing solid job growth.
Finally, new home construction should and must increase. That will help relieve the current shortage and make home price and rent growth more aligned with income growth.
The 2017 housing forecast is for new home sales to rise close to 10 percent as homebuilders get busier. There will likely be no meaningful change in existing home sales from this year’s roughly 5.42 million sales pace, which is still the strongest year of sales since 2006.
All things considered, things are looking up for the housing market, including the interest rate a homebuyer will pay on their mortgage.
Lawrence Yun is the Chief Economist and Senior Vice President of Research at the National Association of Realtors. He is regularly featured on CNBC as a housing market analyst.
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