Rising U.S. Mortgage Rates Threaten Home Affordability and Ownership

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While historically low mortgage rates in the U.S. have been the silver lining in today's competitive housing market, keeping monthly payments relatively affordable even as home prices reached new peaks - but that's all changing. According to Zillow, since the beginning of the 2018, U.S. mortgage rates have increased nearly 50 basis points, and the impacts of rising interest rates are now impacting the U.S. housing market.

At the end of 2017, mortgage payments on the typical U.S. home required 15.7 percent of the median income, according to Zillow's Q4 2017 affordability analysis. In the late 1980s and 1990s, mortgage payments took up 21 percent of the typical income.

If mortgage rates reach 6 percent next year, near the upper end of forecasters' expectations, the share of income needed to cover monthly housing costs on the median U.S. home will be 20.5 percent, nearly the historic norm of 21 percent. But in several large U.S. markets, including San Jose, California, Los Angeles and Miami, mortgage payments already take up a larger share of income than they did historically. In San Jose, the share of income needed for mortgage payments increased from 36 percent historically to 46.1 percent at the end of 2017. Combined with record-high home prices, housing affordability is already suffering in these markets and will only worsen as rates climb.

An additional side effect of higher mortgage rates will be felt in housing inventory, as some homeowners with lower mortgage rates may hesitate to sell their homes and take out a new home loan with a higher rate. Most home shoppers can absorb modest increases in mortgage rates, but once rates begin to approach their historic levels, they will eat into housing affordability for buyers and could limit the number of homes for sale as well. Inventory has fallen on an annual basis for 36 consecutive months, so any factors that further limit inventory will be a strain on the market.

"For nearly a decade now, homebuyers have been buoyed by historically low mortgage rates that made buying a home more affordable than it was for prior generations, but tomorrow's buyers may not be so lucky," said Zillow Senior Economist Aaron Terrazas. "Rates are showing a clear upward trend, bringing an end to an era of historically affordable mortgage payments. Bigger life considerations typically take precedence in the decision to move, but some homeowners who locked in a lower mortgage rate may look to alternatives like renovating their current home instead of becoming a buyer in a stressful, competitive market when higher rates would limit their buying power below what it was when they bought their current home."

Renting doesn't provide much relief as an alternative to home buying. The typical U.S. rental payment requires 28.9 percent of the median income. In 14 large U.S. metros, rent takes up more than 30 percent of the median income, widely considered the standard for unaffordable housing costs.