How high can US mortgage rates climb?

More than 18m American households that could have afforded a property in January now priced out of the market, says National Association of Realtors, as inflation bites

US mortgage interest rates have soared beyond six per cent. It’s the latest blow to prospective homebuyers already facing record house prices.

Average contract rates for a 30-year fixed-rate mortgage hit 6.28 per cent on Tuesday before dipping slightly to 6.03 per cent on Thursday morning, according to Mortgage News Daily, a climb from the 5.65 per cent recorded for the week ending Friday 10 June, which was already the highest level seen since late 2008 when the financial crisis and Great Recession were underway.

That means that mortgage interest rates have doubled over the course of last year, having stood at around 3.12 per cent in mid-June 2021.

The increases are being seen as pre-emptive measures anticipating the US Federal Reserve raising its own short-term interest rates to rein in inflation, which is running at a 40-year high of 8.6 per cent and has been exacerbated by the economic impact of the coronavirus pandemic, associated supply chain disruption and Russia’s war in Ukraine hitting commodity exports and driving up global energy prices.

The American central bank duly raised its target interest rate by 0.75 per cent on Wednesday, its biggest leap since 1994, as it projected a slowing economy and growing unemployment in the coming months, reaching an expected 3.7 per cent by the year’s end.

“Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher energy prices and broader price pressures,” the Fed’s policy-setting Federal Open Market Committee said in a statement on Wednesday. “The committee is strongly committed to returning inflation to its 2 per cent objective.”

In real terms, the increase to mortgage interest rates effectively adds an additional $700 (£579) a month or more than $8,100 (£6,700) a year to outgoing payments on a median-priced home valued at $447,000 (£369,759), according to Realtor.com’s estimates.

That would mean a further $244,000 (£201,837) being piled onto the cost over the lifetime of a 30-year loan.

Such a steep increase would effectively price out 18m American families, or 15 per cent, who could have afforded a new home at the start of the year, according to Nadia Evangelou, senior economist and director of forecasting at the National Association of Realtors (NAR).

“Some of the buyers have reached their financial limits – and they’re out of the market,” she said.

That tallies with Mortgage Bankers Association data, also released on Wednesday, which showed that purchase applications are down more than 15 per cent year-on-year.

The situation will leave prospective buyers having to settle for cheaper properties or carry on renting in the hope of hanging on until the situation improves, although following the latter course threatens to eat into savings as wages stagnate and rents climb, further compounding the setback.

While the threat of rising mortgage costs acting as a deterrent might be expected to force house prices down to ensure sales are made, currently that does not appear to be the case, with buyers instead opting to stretch their budgets as far as possible to secure a purchase before the national economic picture becomes any darker than it already is.

Market supply is also failing to keep up with demand, according to the NAR, which reports seeing an average of five offers on every house put up for sale.

Ultimately, how high mortgage rates might eventually climb depends on how far the Fed is forced to adjust its own rates to tackle inflation, the two rates distinct but their fates inextricably bound, causing them to follow roughly the same trajectory.

One reason for optimism comes from Len Kiefer, deputy chief economist at Freddie Mac, who has pointed out that mortgage levels have reached much higher peaks in the past and gone on to recover, citing the more than 18 per cent seen in 1981, three times above the present total.

“From a historic perspective, it’s not a high rate at all,” he said philosophically.