One of the biggest factors in housing affordability is mortgage interest rates. Mortgage rates increased from 3.11% at the end of 2021 to 5.25% as of May 2022. The last time interest rates were this high was in 2009. A substantial interest rate increase has a significant impact on how much a family or individual can spend on a house.
How does the math work out for homebuyers?
The National Association of Homebuilders estimates that the median price of a new construction home is $412,505 (that’s a median for the US – we know that prices across Montana can vary widely). At a 3% interest rate, an income of $94,624 would be required to afford a median-priced home. But at a 5.25% interest rate, that income would need to rise to $116,300 to afford the same home.
What does that do to the buyer pool?
Simply put, rising interest rates shrink the buyer pool. In the city of Missoula, it’s estimated that around 7,300 households could afford a $412,505 house at 3% interest rate. At 5.25%, the buyer pool shrinks by about 30% to closer to 5,000 total households.
Is there an upside? Sort of…
It is difficult to see an upside to the steady decrease in housing affordability. However, the issue is triggering innovation within the industry. Companies are developing new construction techniques that speed up construction, which helps solve the inventory issue.
But, with inflation, costs are still rising quickly.
Many builders are pivoting to build for rent communities. This allows families to enjoy new construction single-family homes with the flexibility of renting. Cities are revisiting codes and planning regulations to streamline the development process. This lowers development costs and home prices.
The increase in interest rates is decreasing buying power at a time when construction costs are still increasing. In cities like Bozeman, Kalispell and Missoula, a severe lack of housing supply continues to push home prices higher.
For first-time buyers, it is becoming increasingly difficult to break into the housing market. It is estimated that in January 2021, first-time buyers accounted for 26% of existing home purchases, the lowest share since January 2014.
Rising interest rates will likely further impact the ability of first-time buyers to purchase homes and begin to grow equity.
What does this mean for Montana?
In the short term, it means that Montana families will still have a difficult time buying a house. At the same time, more rental options are likely to pop up in the form of single-family communities.
In new home construction, it is unlikely that home prices will drop unless construction costs drop as well. New home construction is beginning to slow. At the national level, single-family housing starts have begun declining, with a 7.3% drop from March to April this year.
Home sales are down about 6% from this time last year – but, the same time, home prices are up and time on the market remains low. For builders, refining product offerings will be critical. Building with the flexibility to sell or rent will help hedge against interest rates.
A focus on building desirable communities with well-targeted amenities and locations will draw interest from existing homebuyers.