Despite four months of very low inflation numbers, reduction of government waste, and strong real wage growth, the Biden-era homeownership affordability crisis still dogs America’s middle class. To fix the broken housing market and make homes affordable again, lawmakers and the public need to understand what caused this cost-of-living crisis.
When President Biden took office, homeownership was not only affordable, but more affordable than the long-run average. But as the government spent the nation into oblivion, that quickly changed.
To accommodate the profligate spending of Biden and the radical liberals in Congress, the Federal Reserve created trillions of dollars out of nothing and purchased debt issued by the Treasury. Simultaneously, the Fed kept interest rates artificially low to reduce borrowing costs for the federal government.
These monetary manipulations sparked the worst inflation in over 40 years. Prices everywhere exploded, but housing costs were particularly hard hit. That’s because the same artificially low interest rates that made it cheap for the Treasury to borrow also made it cheap for potential homebuyers to borrow—and borrow they did!
What people really care about when it comes to buying a home is not so much the home price as the monthly payment, since that’s what must fit in their budget. Record low interest rates allowed potential homebuyers to get ever-larger mortgages and thereby bid up the price of homes for sale, on top of the rising prices from inflation.
The party was not to last, and the worst inflation in four decades was predictably followed by the fastest rise in interest rates in just as long. Suddenly, mortgage interest rates below 3 percent were replaced by nearly 8 percent rates. When monthly mortgage payments quickly doubled, demand dried up, and the housing market began to seize.
The situation also rapidly deteriorated for homeowners, whose below-3-percent mortgage interest rates became golden handcuffs. Selling a home almost always means losing the old interest rate and getting a new mortgage at today’s rates. Therefore, sellers faced the same prospect of their monthly payment skyrocketing if they borrowed the same amount for a new home.
The only way to make the math work in this situation is to sell an existing home for such a large premium that the owner has a very large down payment for the next home, reducing the amount borrowed and the size of the next mortgage. That offsets most of the pain from the tripling of interest rates.
It also means that the price of the median existing home is so stratospheric that it has eclipsed the price of the median new home—a rarity. It’s especially shocking since new home prices have never been higher.
Inflation has pushed up the cost of new home construction by a third in less than five years. Homebuilders today can’t lower their prices, despite high interest rates, because they need to cover their record-high costs on materials and labor. Since many homebuilders finance their projects with credit, high interest rates are another cost increase.
It’s no wonder homebuilder sentiment has collapsed to the lowest level in years while pending home sales are near a record low and a full two-thirds of Americans think homeownership is out of reach for those under 40. The deadly one-two punch of high home prices and high interest rates has essentially killed the starter home.
It’s tempting to blame this problem just on high interest rates and then call upon the Fed to lower rates as an easy fix. But that would merely treat a symptom, not a cause, and any relief to the housing market would be temporary.
Artificially reducing interest rates by one or two percentage points again would simply allow potential homebuyers to borrow more, restarting the bidding war while also sparking more inflation. Pushing interest rates below 3 percent again would eliminate the premium on existing mortgages, but would cause even worse inflation and necessitate even higher interest rates thereafter.
The only way to really thaw this frozen housing market is to allow interest rates to fall naturally. The interest rate is just the price to borrow money, and the biggest borrower is the federal government. Excessive borrowing in Washington DC is the real reason everything from mortgage interest rates to Treasury yields to credit-card interest rates are sky-high today.
Reducing government borrowing will reduce the demand for borrowed money, and that will bring down the price, which is the interest rate—it’s Econ 101. Therefore, if Congress wants to help the housing market, they must spend—and borrow—less money.
E.J. Antoni, Ph.D., is the Chief Economist and Richard Aster fellow at the Heritage Foundation and a senior fellow at Unleash Prosperity.
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