All Posts from Walker
Why Homebuyers Should Ignore The Federal Reserve Right Now
Homebuyers and real estate agents are obsessed with the Federal Reserve right now. This is understandable, given the super-steep rate rise over the past year and a half. But it’s a bit misplaced. If you really want to obsess over something, I’ll give you something more fun than Jerome Powell (not that he’s not a fun guy; he probably is). Worrying about the Fed is just not going to inform any home-buying decision at the moment.
A Quick Primer on The Fed Funds Rate
Typically, the Fed has direct control only over short-term markets, the Fed funds rate. This is the rate banks charge one another for overnight (one-day) loans. Why would banks need to borrow for just one day? They’re required to maintain a certain level of deposit reserves; sometimes a bank closes the day lower than its reserve requirement, and sometimes higher. If a Bank A is a bit low, it’ll borrow at the Fed funds rate from Bank B; if Bank A has extra deposits on hand, it’ll lend to Bank B and pocket the interest. Though Fed funds is an overnight rate, it is always stated as an annualized figure, so you’ll see it as a percentage, like 5.25%.
But mortgage markets revolve around a much longer rate: the yield on the 10-year U.S. Treasury. This is the number borrowers need to look at. And its wonky relationship to Fed funds is critical to understand.
The Fed Funds Rate and the 10-Year Treasury: Like Kids in The Same Homeroom
Sometimes they’re super tight and spend all their time together; later in the year, they get distracted and spend time with the kid who acts like Eddie Haskel. The relationship between the Fed funds rate, upon which so many of us fixate, and the 10-year Treasury, is not static. It’s dynamic. It’s ever-changing. It’s a bit unpredictable. It’s kinda like the kids are in the same homeroom and have a sleepover now and then.
Under certain conditions, the Fed funds rate is some fraction of the 10-year rate, and they tend to move roughly in tandem. This situation produces a normal yield curve, which is what we saw, for example, 18 months ago, on March 21, 2022. (Note that the Fed funds rate shown in these tables is called the effective Fed funds rate, which is an average of all the Fed funds trades that day.)
On March 21, 2022, Fed funds was 0.33% and the 10-year at 2.32%. Again, this shape is a normal yield curve, what bond managers kinda like to see.
Yield Curve 18 Months Ago: March 21, 2022
Let’s fast-forward 18 months, to yesterday.
Those kids! They never know what their deal is! Now you see the effective Fed funds rate at 5.33% (all those rate hikes have had an effect, after all) and the 10-year yield at 4.37%. Huh? Fed funds are higher than the 10-year? Well, bond markets are measures of risk, and right now the markets see more risk to the economy over the short term (the next few months) than they do over the long term. They’re not buying all this “soft landing” talk. So short rates are higher and long rates are lower. This is called an inverted yield curve. Not a big deal, really.
Or is it?
The Yield Curve Yesterday: September 19, 2023
When Things Get Unpredictable, Watch the 10-Year!
In fact, you should always watch the 10-year, and the next chart will show you why. Fixed mortgage rates are priced off of the 10-year Treasury (variable-rate mortgages are priced off of short measures, but the vast majority of new home loans right now are fixed).
Now it gets interesting. We’re looking below at yield-curve data that’s six months apart. The green bars are yields as of March 20, 2023, and the blue are yields as of September 20, 2022 (my source for these data is the Federal Reserve Bank of New York, by the way). Note that as of September 20 of 2022, the effective Fed funds rate was still at 2.33%, as the Fed was midway through its tightening cycle. The 10-year at the time was at 3.57%. Six months later, Jay Powell had raised the funds rate a few more times and by March 20 of this year, effective Fed funds was at 4.58% (remember the effective rate is a weighted average of all the Fed funds trades that took place on a given date).
What did the 10-year do? Nothing. Nada. Zip. Yawn. Zero. Numero nada.
With funds having moved upwards by 2.25% in six months, the 10-year Treasury yield sat still, ending that day at 3.47%. The takeaway: 10-year U.S. Treasury yields often moves in the same direction as the Fed funds rate and often by roughly the a similar amount, but not always. Sometimes the relationship gets kinda crazy and wonky. Remember that fixed-rate mortgages are priced off the 10-year.
Yield Curve Comparison: Fed Funds Doubled But The 10-Year Refused to Budge
This Begs The Question: What the Heck?
One can infer that six months ago, the markets (as now) perceived more risk in the short term than they did in the long term, because the 10-year refused to move higher. This is a reasonable interpretation.
What happens if and when the perception of long-term securities having more risk (more time for stuff to go wrong) begins to normalize? 10-year yields would climb, without the Fed having done a darn thing.
In fact, Jerome Powell could sit on his hands for nine months and do nothing (which I’m sure he’d be glad to do, after all this) and the 10-year could climb by half or even a full percent. While it’s the norm to obsess over the rates that are set by a small group of humans called the Federal Reserve Open Market Committee, it’s wiser and more fun to obsess over the rates set by millions of bond buyers and sellers worldwide: the 10-year U.S. Treasury yield.
If you’re in the market to buy a home, ignore Jerome Powell for now. The potential threat of climbing long-term rates is what you should to attend to.
What My Childhood School Taught Me about Relationships
It’s about Time in The Saddle
A couple of weeks ago, I found myself involved in a rather spunky conversation at a favorite local general store and dive called Tesuque Village Market. After the Syrah wore off (it took a good while, to be honest) the chat made me think a bit. Topic? The school I went to in Houston as a kid, which at various times can be quite accurately described as “insular,” “elitist,” “cloistered,” “rigorous,” and “cultish.” St. John’s in Houston was all of those things, and to this day remains so without apology, for better or worse.
Over time, St. John’s people tend to keep in touch and maintain extremely close personal friendships which, to a large extent, define their lives. “Same as everywhere,” a skeptic might say. But at St. John’s this is much more the case than with other institutions. I began to wonder why. In fact, I’ve thought about it a lot. It carries over into other relationships too. If you are a St. John’s person, you will think about it.
To many of us, St. John’s was an experience with traumatic elements: it was and remains hyper competitive, so challenging at times that it seemed like the objective really was to make hamburger out of us. It was relentless. It was monotonous and all-consuming, unpleasant, even. Why, then, did we not scatter to the winds after graduation and stay away from each other? Some do, but most don’t. What’s unusual about it, though, is that over time, we continue being close.
So I pondered.
Was it somehow a bonding experience to endure Mr. Stockman’s English class or to stare into the empty cubicles of Study Hall 40? Yes, those shared experiences are important, but that ain’t it.
An analogy helps: there’s an expression among cyclists about what matters in the sport if you’re to take it seriously and race: “time in the saddle.” It’s not so much how hard you train or how you ride or whose wheel you’re on, but how long you’re on the bike.
So I did some math.
“Lifers” at St. John’s make it from kindergarten through 12th grade. At roughly 190 days a year, we would have put in 2,483 days together by graduation. That’s 17,381 hours together. You tend to get to know one another with that much time.
So, you see where I’m going with this. It’s not the institution itself that influences how we “do” relationships, but the bare fact that we were together for so long. It’s time in the saddle. I was there 10 years, and those friends are still friends. I chat almost every week with my boss from my first advertising job in Houston (Hi Carol!) and to colleagues from a money markets trading job which followed a few years later. This carries into romantic relationships for at least two of us from the class of 1984. In Taos, NM, I married my kindergarten classmate, whom I’ve known since 1972. So much of life is about just being there versus not. We’re not all perfect, but if you stick together long enough, you do ok.
The 99th Burning of Zozobra: Bad News for Gloom, Anxiety, and Cares of All Sorts
Burning man is but a child and a badly misguided one, at that.
The burning of Zozobra is a now 100-year-old Santa Fe tradition that can befuddle tourists and newcomers alike, but which has become central to the culture of this place. It seems a bit sinister, and that’s by design. His burning represents the incineration of cares, wants, anxiety, and gloom. Full of contradiction, Zozobra’s torching actually carries a positive, healthy message. Only when you hear mass collective chants of “burn him!“ and “burn, puppet” and (my favorite) “burn, pinche puppet!” will you gain a feel for what Zozobra means to Santa Fe.
It started back in 1924. Artist Will Schuster crafted the first Zozobra, later to torch it with alacrity at a local yard party. His invention wasn’t pulled from thin air, but rather drew inspiration from local Catholic holy week practices. Schuster co-opted the Spanish word Zozobra (meaning anguish, anxiety, or gloom) and his pyrotechnics became a festive means for laid-back and content Santa Feans to cast off cares and gloom of daily life and look ahead to a year free of worry.
Below are some photos from this, the 99th burning, courtesy of my good friend Jen Perez.
Why “Higher for Longer” Will Change the Complexion of Real Estate Markets
I wrote recently that certain of the assumptions behind mortgage borrowers’ “I’ll wait a bit until rates go back down” thinking are likely flawed, though understandable. Many of us, especially those under, say, age 45, have seen abnormally low rates for decades. All the way back in 2001, following the September 11 attacks, the Federal Reserve cut the funds rate (the rate big banks charge one another for overnight lending) to 1.75% and later to below 1.00%, depicted in the Fed’s chart below. Mortgage rates followed suit.
Just how abnormal those extremely low rates were is what’s not well understood.
Personal Experience Shapes Interest-Rate Expectations
Let’s take an example of a 45-year-old homeowner couple in their second home. For virtually their entire adult memories, the Federal Reserve has engaged in highly unusual stimulus designed to push short- and long-term rates to extreme lows (the chart shows the Fed funds rate from 2005 to 2023). With the exception of the spike after the post-9/11 recovery, Fed funds have remained low until very recently. Behaviorally speaking, the recent period of higher rates feels quite unpleasant and abnormal to a couple younger than 45, while a Fed funds rate at 0.75% and mortgage rates around 3.25% seems like the norm. After all, it’s what they’ve known for more than 20 years.
But Future Low-Rate Expectations Are Likely Flawed
Given the limits of experience, some Americans have settled on a perfectly reasonable but flawed assumption that rates will fall to those lows again soon. But with the Fed funds rate now at back 5.50% and economies arguably entering a different era, many (including former treasury secretary Larry Summers) believe the 10-year U.S. treasury note will stay in the 4.50% to 4.75% range for most of the next decade.
If that’s the case, mortgage rates would fall in the 7.00% to 8.00% for most of the next decade too.
A Smaller Market with a Different Mix of Sales
More than 60% of U.S. homeowners have mortgage rates at or below 4.00%, and when it comes to making a decision to move, generally those homeowners, rationally, don’t intend to budge. If their mortgage rate jumps from 3.75% to 7.10%, for example, those homeoners wind up paying significantly more in interest every month just to stay in a similar home – much less to upgrade to a more expensive home. This effect has dramatically reduced existing home supply, while prices remain high because of healthy demand. In effect, national housing markets are now smaller. But what’s ahead?
The Next Act: New Home Building Surges, Buyers Get Tired of Waiting?
New home builders have jumped in to fill the gap in supply caused by homeowners unwilling to budge. That trend will likely grow. As the market moves forward, new home sales may constitute a larger proportion of sales. And another effect is likely to gradually take hold. If (as I expect) rates remain elevated for a period of years, potential buyers will get tired of waiting and will make decisions they’ve long delayed.
Some commentators have pointed out that housing costs are now alarmingly high, with purchasers having to devote a larger portion of their monthly payments to interest cost. Yes, interest cost are higher. But since the 1990s, the proportion that a family devotes to housing has varied widely over time, according to the U.S. Census Department and Freddie Mac data. This supports the notion of homeowner and market adaptability. When some of those homeowners who tire of waiting re-enter the market, it will ease supply constraints somewhat. And my guess is that it’ll be a couple of years before significant numbers of them throw in the towel and sell.
The Income Factor Has Not Been A Determinant for Many Home Buyers
In the meantime, bare lot sales and new-home sales will likely constitute a growing market share. So, “Higher for longer” will change the market mix and mute sales volumes, but as always, the market will find ways to adapt.
A Quick Santa Fe Market Update
Santa Fe is unusual among real estate markets in that it’s small (the city’s permanent residents number only 85,000 or so) but buyers come from all over the country. Our most significant feeder markets have typically been Texas and California, but driven in part by overcrowding on the Front Range and outlandish home values, Colorado has emerged as a leading supplier of Sotheby’s buyers for homes over $750,000.
Geographic Origin of Sotheby’s Santa Fe Buyers of Homes over $750,000:
Year to Date through August 2023
- Colorado: 16
- Texas: 16
- California: 14
- New Mexico: 8
- Arizona: 3
Three Reasons To Hike Santa Fe Baldy, Even if You Think You Can’t Make it to the Top
It’s got a reputation as the king of the local day hikes. It’s long. It’s difficult. It’s steep. Making it to the summit is no small feat. But many Santa Feans shy away from Baldy for fear they can’t make it to the summit, and that the hike is somehow punishing. Monster mistake! Santa Fe Baldy is in fact about ten wonderful, amazing hikes rolled into one. There are scads of reasons to attempt it and if you can’t or don’t want to summit, to make a diversion along the way. Each is a worthy destination: Nambe Lake, Puerto Nambe, and the saddle a few hundred feet below the summit.
Reason 1: Gorgeous Nambe Lake
You’ll start at the Santa Fe ski basin and walk a series of switchbacks up to the gate to the Pecos Wilderness, about 600 feet above the trailhead. From there, you’ll stroll (and probably trip, because it’s rocky here) through a gorgeous aspen grove, across some flat terrain, and down the side of the slope. After a bit you’ll see a trail sign for “Elevator Shaft” on the left, clearly meant to be ignored.
About a mile farther down, you’ll see the sign for the trail to Nambe Lake, which is reason #1 to try Baldy: it’s simply the best bail-out hike on the planet. The streamside climb up to the lake is tricky and strenuous and the trail disappears a bit at times, but using a bit of common sense gets you up to the lake. It’s a fantastic reward.
On the upstream side of the lake (which lies at about 11,400 feet) you’ll see a talus slope and Lake Peak overhead. Spend time exploring the trail and head down the way you came, and you’ve just done a wonderful hike in about four and a half hours.
Reason 2: An alpine meadow called Puerto Nambe
Don’t need or want to bail at Nambe Lake? Stay on Windsor trail past the turn to the lake, and across a pair of streams. You’ll climb a few switchbacks to a trail junction about four and a half miles from the ski basin, and this’ll then open up to a remarkable and beautiful alpine meadow at about 11,000 feet, called Puerto Nambe. After having climbed along rather skinny aspen-, spruce-, and fir-lined trails, Puerto Nambe comes as a surprise, and it’s beautiful. There are often more than a few campers there, and it’s a gathering spot, a worthy destination in itself.
Reason 3: The Saddle
It’s important to take trail 251 (Skyline trail) at the Puerto Nambe junction. Now a bit of hard work begins, as you climb up a rather long series of switchbacks and reach a saddle, from which you’ll take in astounding views to the north (toward Colorado) and to back toward Deception, Lake, and Penitente peaks.
Baldy is set off a bit on its own from these and father north; the saddle bridges that gap. In my opinion, it’s the most beautiful and rewarding part of the hike. You’re approaching treeline, so the spruces and firs are smaller, the boulders striking, and the New Mexico sky immense. If summiting seems implausible at this point, head down. You will have done a wickedly nice hike.
Straight Up to The Summit
Still got it? Lungs not that angry? Strike for the summit. This section is steep, rough, and rocky. As is typical of trails near mountain summits, they diverge, become hard to see, and disappear in places, but the objective is obvious. You’ll have to stop briefly a few times to remain on good terms with your lungs, and it’s important here (and all along the trail) to stay very well hydrated. After an hour or an hour and a half, you’ll walk along a ridge with a view down to Lake Katherine.
Then you’ll reach the summit, with its clear views in every direction — and its ridiculously giant cairn. Enjoy a half hour or so at the summit before heading down the way you came, and depending upon your speed, you’ll reach your car anywhere from five to eight hours after you left. A caution: Alpine hikes like this one are best NOT attempted in rainy season when storms and lighting at the peaks are a possibility, so it’s best to wait ’til after monsoon season to give it a shot during the fall, before the early snows. The best trail book to consult is still (in my opinion) The Sierra Club’s “Day Hikes in the Santa Fe Area.”
Former Treasury Secretary Larry Summers Believes Long-Term Rates Will Remain around 4.75% for The Next Decade. This Means Mortgage Rates Will Follow. Wither Housing Markets?
I recently saw an article on Bloomberg stating (from a perfectly credible source) that mortgage rates will have to decline to 5% in order to unlock significant supply in the housing market. Two assumptions underlay this article, which I won’t link to: 1) mortgage rates will decline to 5% in the medium term and 2) supply in the housing market will be unlocked during the same period.
Neither is an assumption that I can back up with any real data. In fact, my view is that it may not happen at all.
Former U.S. Treasury secretary Larry Summers’ outlook is that long-term rates will hover around 4.75% over the next decade (the 10-year U.S. Treasury note closed at 4.25% on Friday) and it’s underpinned by real data — not to mention the fact that he is among the most respected financial minds in the country. What’s behind Summer’s view of a 4.75% 10-year?
To paraphrase:
- Inflation, which he said is likely to trend at a faster pace than in the past, perhaps 2.5%.
- The need for more defense spending, likelihood of some Trump administration tax cuts getting extended and higher average interest costs on outstanding debt.
- The usual term compensation investors get for buying a longer bonds rather than rolling over investments in short-term ones.
If the 10-year stays around 4.75%, mortgage rates will remain around 7% to 8%.
Read the Summers interview here: https://tinyurl.com/10-YrUST/
Hang on a minute.
I’m in the real estate business, and it’s perhaps a bit odd that I am seemingly telling people that rates will remain high for the foreseeable future. Well, as (credible) economists are fond of saying, nobody knows what will happen. I certainly don’t. There could be some sort of exogenous shock to the economy (as there was in September 2001 or during the worst of the covid crisis) that upends these assumptions and drives rates down. Barring that, let’s look at what this means for home sellers and buyers.
If mortgage rates remain in a 7 to 8% range, housing supply will very likely remain constrained (to what extent, again, no one knows) by the mortgage-rate lock-in effect, which keeps homeowners in their homes. Constrained supply contributes to firm prices. So even as sales volumes decline, pricing may remain relatively firm. That’s what’s happening now in Santa Fe and northern NM. We see it everywhere. Over time, though, as the shock of higher rates wears away, this effect may subside a bit.
For buyers, lower volumes mean more balance in negotiations. Inspections that were once waived are happening again, and four-bidder offers are something of a memory. As buyers contemplate the fact that they may pay (over time) $75,000 more in interest on a mortgage, those same buyers may save $75,000 in the purchase process. That’s a tangible benefit of the slowdown.
What can we conclude?
The former Treasury chief highlighted that many elements apparent today suggest that “the economy is in a different era.” With markedly lower supply and mortgage rates “higher for longer,” the housing market may be heading into a new era too. And what will that mean? It’d be reasonable to watch new-home building activity as builders seek to fill the supply gap. It’d be worth watching land and lot sales for the same reason. And it’d also be wise to look at to what extent sellers with low-rate mortgages prove more willing to sell over time.
See my Sotheby’s page at https://www.walkerstewartsantafe.com
Waiting for Mortgage Rates to Come Down? Examine Your Assumptions First.
It’s a phrase I’ve already heard countless times. “When rates come down, I’ll [insert action here].”
If you’ve worked in the capital or mortgage markets, you probably know how bond yields (and mortgage rates) work. But if you’re like most people, it’s a bit opaque. Well, you’ve come to the right blog!
The federal government borrows in the capital markets for short periods of time and for quite long periods. Forty years ago, the U.S. Treasury borrowed for 30-year terms routinely. Now that’s not common; the government usually borrows for 10 years at most. And the treasury borrows most funds for shorter periods: one year, two years, six months, three months, and even overnight.
The Federal Reserve (and its chair, Jerome Powell) only has absolute control (let’s call it) over short rates – overnight, though they can exert control over long-term markets; that’s a subject for another post.
Fixed-rate mortgage pricing in the U.S. is almost exclusively set off of the 10-Year U.S. Treasury. The problem is that the government doesn’t set those rates. In fact, it has very little control over them. 10-year rates are set by the markets and expectations of future economic growth or stagnation, roughly speaking.
Current U.S. Treasury Yields for Maturities from Three Months to 30 Years
Note that in the table above, the 3-month Treasury bill is at 5.43%, while the 10-year note is at 4.22% and the 30-year bond at 4.32%. This is known as yield curve inversion and it’s not terribly common, and will likely not persist over the long term.
Back to the Fed. The Federal Funds rate is a target range set by the Fed which is the rate at which U.S. banks borrow from each other overnight (the “Discount Rate” is the rate at which banks can borrow from the Fed and it’s usually a bit lower than the Funds rate). Anyway, in its recent effort to rein in inflation, the Fed raised the Funds rate from 0% to 5.50%. Since most consumer lending is set off of short rates, borrowing slowed, so did spending, and so has inflation. Great. So rates go back down now, right? Not so fast.
The problem is that the Fed Funds rate and the 10-year Treasury rate are almost entirely unrelated. So, if Chairman Powell is indeed at the end of his tightening cycle and may even lower the Fed Funds rate next summer (as Goldman expects; see link below), this may mean almost nothing for mortgage rates.
I’ll write that again: If the Fed eases rates next summer, it may mean almost nothing for mortgage rates.
The 10-Year Treasury, off of which mortgages are indexed, is, as of this writing, more than 125 basis points (1.25%) lower than the (overnight) Fed Funds rate, at 4.23%. The markets are charging the government less to borrow for 10 years than they are to borrow overnight and get paid back tomorrow. Why? The 10-year is a bit low right now because there’s uncertainty about whether we’re heading into more of a slump or into a growth period. But most people don’t really know why the curve is so inverted right now. And that’s kinda the point.
Plausible and equally likely scenarios for the next year:
• The Fed eases 25 bp in about a year (let’s just say) and 10-year rates stay flat
• The Fed eases 25 bp and 10-year rates, by then, are higher, maybe at 5.00%
• The keeps the Funds rate at 5.50% because of other inflationary threats, and the 10-year drops
So though short rates may start to come down in the medium term, nobody really knows what the 10-year will do. Given that that rate is lower than the Fed Funds rate by more than 1%, it’s reasonable to conclude that the 10-year may be higher in a year.
If the 10-year is higher in a year, then mortgage rates will be higher, not lower.
So “I’ll wait until rates are lower” may be a long wait. It may be a 90-day wait. It may quite easily be a two-year wait. It may be a three-year wait. Nobody knows. But it is very plainly a mistake to assume that if the Fed lowers short rates, long rates will follow. They are simply not that closely correlated.
See Bloomberg’s recent story on Goldman’s rate expectations below.
What to Expect from ‘The New Mexico Life’ Blog
This blog is something of an act of self indulgence.
I adore living in northern New Mexico. I view it as a deep privilege to be here, to be a part of the culture, to be among the lovely and warm people, and frankly, be able to write about it. So I am.
Roughly half of the posts’ll be on living in New Mexico (thus the name) and the other half on topics outlined below. In that respect, The New Mexico Life blog may seem like naked boosterism, and have no issue with that. It’s a cool place! And if, for some terrible and inexplicable reason, you don’t live here or visit somewhat regularly, I’ll seek to change that. Indulgence No. 1!
On the other end of the content spectrum, I indulge my wonkish, nerdy, and analytical self in evaluating and describing the state of national bond and mortgage markets, real estate trends, and the Santa Fe real estate market, which will be covered at a pretty granular level, to borrow a much-abused business phrase. Indulgence No. 2! Isn’t this fun?
These two types of content, as you might imagine, often intersect. And that meeting is why I think this blog’ll be an interesting exploration.
My first wonkish post uses a research piece published by Freddie Mac as a hopping-off point to look at why the supply of residential property nationwide has contracted so vastly. Entirely nerdy and geeky stuff, but it’s fascinating to examine how it all works. Not everything about real estate markets is “location, location, location.” A reading of that post will show you that the most important factor right now (nationally and in Santa Fe) is monetary policy, monetary policy, monetary policy. We can all thank Jay Powell for that.
I’ll tie it all together for you.
What You Won’t Find Here
There are certain kinds of content I’ll avoid like the plague (not just the regular old plague, but the 1351 plague, which was the whopper):
• Property listings — there are many places for listings. Not here. Unless it’s a house that has particular cultural or historic value, it ain’t gonna be here.
• ‘Rah rah’ circusy stuff — The New Mexico Life is aimed at entertaining and informing those of us who live here (and those who don’t yet). It’s not cheerleading room for someone’s roofing business.
• Speculation or conjecture — Regarding posts on economic issues, you won’t find articles on the bond, mortgage, or real estate markets which are not backed up by data and which are not well sourced and researched. I’m trained in the highly regulated field of investment management and am reflexively careful about what I write. One learns to be cautious when FINRA’s hovering over your desk, waiting to slap you with a ruler.
What You Will Find Here
• Explorations of the wonderful, positive things about New Mexico, and northern NM in particular.
• An occasional post about economic, educational, or governmental issues within New Mexico.
• Articles on the bond and mortgage markets, what drives them, and how to better understand them.
• Posts on related national economic developments that may affect on mortgage or real estate markets.
• Insights and data on local real estate markets, tailored to help us all better understand what markets are doing now and what they may do in the near future; the first of these (on bare lot sales in Santa Fe) is already posted.
• Probably a lot of typos.
• Some seriously funky and inventive grammar.
—JWS
The Mortgage-Rate Lock-In Effect Constrains Supply and Brings Leverage for Buyers
The mortgage-rate lock-in effect.
It’s finance speak for homeowners knowing a good deal when they have one.
With 30-year mortgage rates having dropped below 3% as the Federal Reserve forced short and long-term rates to artificially low levels for more than 20 years, housing markets are now grappling with the hangover effects of that stimulus. One of those effects is the mortgage-rate lock-in effect.
For Americans with mortgage rates at or below 4.00% (six in 10 of us, according to Freddie Mac), the interest savings on a low-rate loan has a behavioral effect: it keeps homeowners where they are, in their current homes, reluctant to leave the sweet deal of a 3.15% loan. Rather than considering moving to a new city or just over to a new neighborhood with rates above 7%, homeowners, both in New Mexico and nationally, have stayed put. In a big way.
The effect of those mortgage holders staying in their homes is constraining the supply of existing homes nationwide. The lock-in effect “is the largest ever in U.S. history and is likely to impact the housing market for years to come,” writes Freddie Mac in its Economic, Housing, and Mortgage Market Outlook for July 2023, which cites the following example to illustrate the effect. “Suppose a lucky homeowner has refinanced their mortgage of $250,000 at 2.65% in January of 2021. Their current monthly principal and interest payment would be $1,007 and after 29 months of payment their current outstanding balance would be $236,379. If the borrower obtained a new 30-year mortgage of $236,379 at the prevailing market interest rate of 6.81%, their monthly payment would increase to over $1,500 a month. The value of mortgage rate lock-in is $86,136 in this example.”
For the average 15- or 30-year loan in Freddie Mac’s portfolio in Q2 of 2023, the holder saves upwards of $55,400 over the life of the loan versus an equivalent deal at today’s rate, as shown in the chart below (the far-right bar). This is just for the average mortgage holder! $55,400 of lock-in effect is a powerful disincentive to moving!
Look at the same chart and you’ll also note that in Q4 of 2020, when rates were at all-time lows, the average holder of a loan in Freddie Mac’s portfolio would have sacrificed $23,200 in interest savings by not moving or refinancing.
Homeowners are choosing, for now, not to leave savings like this on the table. But with these constrained existing-home supplies, new home construction is apparently surging to fill the gap. The demand remains, after all! This development is reflected in the Santa Fe market. Lot sales have grown meaningfully over the last few months. For May, June, and July 2023, bare lot sales rose 11.36%, 10.71%, and 36.59% respectively over the year-ago period.
Buyers, however, may benefit more from balanced Markets. In Santa Fe, we’re no longer seeing quite as many one-sided, risky purchase contracts written with inspections waived, multiple bids above asking price, and other provisions that prove unfavorable to buyers. Some balance has returned.
So, while mortgages with a 7% handle may seem a bad thing, higher rates may save buyers from having to overpay for a property in a transaction laden with excess risk. it’s important to note that the potential reduction of risk and greater negotiating leverage may exceed, in dollar terms, the negative effect of higher rates. That may be evident in negotiations.
So while we all grew accustomed to the thrill of artificially low rates which were a product of forceful Fed stimulus, more normal rates have returned leverage to the buyer, and that’s a good thing.
Read the full Freddie Mac story below.
Sources: Freddie Mac Economic and Housing Research Group, Santa Fe Association of Realtors
What’s Going on with Bare Lot Sales in Santa Fe?
It’s fair to say that the residential real estate market has slowed from a gallop to a trot in Santa Fe. If you haven’t read the previous post on the mortgage-rate lock-in effect, it’s got some great information, courtesy of federal housing agency Freddie Mac, on what’s accounting for some of the slowdown.
Why then, are bare residential lot sales seemingly booming in Santa Fe? I insert “seemingly” here because though three months of increased-sales data (which is what we’ve got), may indicate a trend, it does not necessarily point to a long-term pattern. Time will tell that.
For May, June, and July of 2023, Santa Fe land sales actually increased by 11.36%, 10.71%, and 36.59% over the like year-ago period. Why? Let’s look. Lots aren’t financed with mortgages, but they are often acquired with loans of one stripe or another (construction loans, etc.), all of which are higher. The Fed Funds rate’s now at 5.50% and the 10-year U.S. Treasury benchmark around 4.15%. With loan costs higher across the board, what’s driving the increase?
Residential Lot Sales in Santa Fe by Month, 2019 through July 2023
Well, we’ve seen dramatic contraction in supply due primarily (or exclusively, depending upon how you look at things) due to higher mortgage rates, which as of this writing stood at an average of 7.09% for a conforming loan.
Demand in the housing market hasn’t really taken orders from the supply side too well, in some respects. Demand in housing remains high and tends to be inelastic, resistant to short-term change and pricing shocks. If existing-home supply continues to abate, new home construction may continue to fill the gap.
And increased new-home construction means increased land sales.
It is important to note that three months do not make a trend. It’s a good idea, though, to keep an eye on what happens with lot sales in Santa Fe and nationwide. It seems plausible that higher lending rates will have (somewhat ironically) fueled a new-home construction boom, simply to meet the persistent and ever-present demand for housing in the U.S.
Sources: Santa Fe Association of Realtors, Fannie Mae