How Buyers' Misconceptions About Mortgage Rates Can Be Hurting The Housing Market

The real estate market has changed considerably in the past few months in numerous ways, but reports indicate that today's buyers may have some misconceptions about market conditions and home affordability. Home prices are high, with the National Association of Realtors reporting in February that home prices had risen a staggering 42% in the previous three years. The good news is home price increases have slowed, but mortgage rates continue to be a sore spot for home buyers.

With home prices remaining high, buyers are not willing or able to take on loans with higher interest rates. Even a percentage point or two higher may push them out of their comfort zone in home affordability with higher monthly payments. A survey reported by CNBC by John Burns Research and Consulting found that 71% of people in the housing market right now are unwilling to take on a loan that has an interest rate of over 5.5%. Here's the key problem, though. Current rates are trending around 6.4%, making it hard for people who want to buy a home to even attempt the process, and the belief that today's rates are too high is somewhat unfounded.

Many of today's home buyers believe that rates should be much lower, but that's not truly the norm. Rather, data from Freddie Mac indicates that, according to historical data from 1971 through 2022, the actual average rate paid by home buyers was 7.75%. In the 1980s, average rates were over 10%, and in the early 2000s, they hovered around 8%. It wasn't until 2020, when the pandemic hit, that rates dropped to truly historic lows of 3.72%. In short, what today's consumers believe is normal — at under 5.5% — is still very low.

The differentiating factor here is that home prices remain very high. The higher the price of homes, the more difficult it is for even a slight increase in mortgage rates to be considered affordable. A high monthly payment makes it much harder to consider buying. Mortgage rates have ticked up in the last year due to the Federal Reserve's moves to raise the key lending rate in an effort to bring down rapidly rising inflation.

For many people, the goal is to wait it out and hope rates drop to significantly lower levels. A survey reported by U.S. News & World Report found that as many as 66% of people are sitting on the sidelines waiting for rates to start to come down before they enter the market. That could be a wise financial decision, but most experts don't expect rates to come down significantly any time soon, and they may not drop to 2020 figures at all. That survey shows the impact of high home prices and interest rates, indicating that 86% of people feel the home-buying market of 2023 is stressful.

For some, wages have not increased equally to match the higher cost of inflation, home prices, and interest rates in general. For other potential home buyers, the thought of paying so much more now to buy a home than it would have cost just 18 months ago is enough to keep them out of the market, even if they can afford the costs. In all situations, that's hurting the housing market as fewer buyers are entering it, and homes may sit longer.