Homebuyers are freaking out about rising mortgage rates. But maybe they should be celebrating.
Since the close of 2021, the rate on the 30-year home loan spiked higher at a rate never before seen in a four-month span, surging from 3.1% to 5.25% at April’s end. It’s 5.10% as we write. For prospective home buyers who have spent the last couple years chasing rising housing prices amidst tight inventory, the mortgage rate surge likely feels very frustrating.
While the 30-year mortgage rate is still lower today than it was for any month except one (June 2003) from the 1990s to the Great Recession, on an annualized basis rates are rising faster than at any time in 40 years.
But homeowners – and those looking to buy a home – should be feeling good about the level of current mortgage rates. That’s because real mortgage rates (the 30-year rate adjusted for inflation) have turned negative. In the current scenario – which may last for a while — you can live for “free.” At least from an inflation-adjusted standpoint.
To see if you have a negative real mortgage rate, take your mortgage rate and subtract it by the latest inflation rate. If the percentage is less than zero percent, then you have a negative real mortgage rate. If you do have a negative real mortgage rate, you should probably slowdown or stop paying extra principal because technically you’re borrowing free money.
The May 11 Consumer Price Index (CPI) report came in at 8.3%. With the 30-year mortgage at 5.10%, the current real, inflation-adjusted mortgage rate is -3.2%.
If you bought a house with a mortgage rate of, say, 2.5% in 2020, your real mortgage rate equals 2.5% minus 8.3% = -5.8%. Not bad.
A negative real mortgage rate of 5.8% means that in inflation-adjusted terms, you’re essentially getting paid to borrow at a rate of 5.8%. Free money! Or it might be viewed as a 5.8% decline in the real cost of one’s mortgage.
The faster overall prices are rising, the lower your inflation-adjusted mortgage payments will be in the future. The higher the inflation, the more the real cost of your debt gets inflated away. And the higher the inflation, the more the price of certain assets tend to go up, including potentially residential real estate. Therefore, for homeowners with a mortgage, inflation could act as a double win.
So, a case can be made that one should try to hold onto as much of their primary residence mortgage as possible, especially while home prices are rising. Paying down extra principal in this scenario doesn’t make the most sense.
Today’s large negative real mortgage rates are an anomaly. In most economic environments, real mortgage rates are positive, not negative. As recently as December of 2020, new buyers were booking mortgages at 2.7%, while the CPI languished at just 1.3%, putting the real home loan rate at 1.4%.
The blue line below represents “real” mortgage rates – the fixed 30-year mortgage minus CPI. As you can see, real rates are hitting nearly uncharted levels. Homeowners should be happy. And new buyers should consider that maybe higher rates haven’t closed the door on their dream of home ownership.
But how long will this interesting scenario of negative real mortgage rates last?
The 10-year treasury bond yield has risen from around 1.5% at the beginning of the year to 2.76%. This signals the bond market thinks elevated inflation might stick around for a while.
According to Steve Hanke, a noted monetarist and Johns Hopkins professor of applied economics, it’s extremely likely that inflation will remain higher, maybe much higher, than the 30-year mortgage rate for a considerable period. He predicts that the CPI will hover over 6% this year, and stay above that level for all of 2023 and possibly into 2024.
Meanwhile, some prognosticators, including Ed Pinto, director of the American Enterprise Institute’s Housing Center, believes the housing market could keep chugging along. “Nationwide, houses should appreciate the mid-teens this year, and around 11% in 2023,” he predicts. He points out that the fast rise in rents, now advancing at an annual rate of 17%, is attracting investors to increase their portfolios in the single-family home rental market. “I see all green flags with rates at between 5% to 6%,” says Pinto. He believes that it will take another jump to the 6% to 7% range to greatly slow appreciation.
So, if you’re a homeowner with a mortgage, sit back and enjoy the negative real mortgage rates. Everyone loves getting something (relatively) for free.
Steve Sapourn is an active real estate investor, Aloha Capital’s co-founder, and portfolio manager. At Aloha, Steve has overseen more than 1300 real estate investor loans in 35 states. He has managed alternative investments in a variety of asset classes for over 25 years. He has deep experience in designing low-risk portfolios that reliably outperform benchmarks. Over his career, Steve has served as portfolio manager for a Fund of Funds, where he analyzed hundreds of alternative investment strategies. In addition, he has developed and implemented quantitative trading strategies in the futures, stock, and volatility markets. Steve’s long and diverse career benefits Aloha’s investors.