Buying a House? Why Lower Interest Rates May Not Be the Answer in 2024

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I’m going out on a limb today to say: No, a “high interest rate” is not the problem in today’s housing market.

In fact, the “high interest rate” is actually a bit of a red herring: It’s not the core of our issue, and the solution to our current predicament of low housing affordability is not lower interest rates. In fact, that’s what got us into this mess! So today, we’ll talk about how the current situation stacks up to years past, the strange upsides of higher interest rates, and the decision to rent or buy in 2024.

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Our show is a production of Morning Brew and is produced by Henah Velez and Katie Gatti Tassin, with our audio engineering and sound design from Nick Torres. Devin Emery is President of Morning Brew content and additional fact checking comes from Scott Wilson.

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Mentioned in the Episode

• Historical mortgage rates, starting in the 1950s

• The history of the 30-year fixed rate mortgage

• Record low home affordability today

• Plunder: Private Equity’s Plan to Pillage America

• Today’s interest rates for the 30-year fixed rate mortgage

• Median sale prices of homes in 2020

• 72% of existing homeowners have a sub-4% interest rate

• “A 30-Year Trap” from Harvard economist John Campbell

• Price-to-rent ratio in US major cities

• Speculation the Fed may cut interest rates in Q1 2024

• 3-year annualized returns on housing are ahistorical

• Stats on housing starts

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Katie:

The national conversation about interest rates has felt constant since the Fed started raising them in 2022. The rates were a little like Taylor Swift. We all knew they were there, but suddenly they were everywhere you turned. The consensus, unsurprisingly, is that they are too high. I can scarcely remember another cultural moment during my lifetime when they were such a hot topic of conversation, but their financial tyranny is mostly driven by a singular implication. Most people care if the Fed moves a couple of basis points in one direction or the other for one reason and one reason alone: housing. Welcome back to The Money with Katie Show, Rich Humans. I’m your host, Katie Gatti Tassin, and I’m going to go out on a limb today to say no, I don’t think a high interest rate is our problem.

As you’ll see, the high interest rate is actually a bit of a red herring. It’s not the core of our issue, and the solution to our current predicament of low housing affordability is not lower interest rates. In fact, that’s kind of what got us into this mess. If you’re scrolling Zillow every night before bed and praying that J Pow has a change of heart, you might be paying attention to the wrong indicator. Today we’re going to do a few things. Number one, we’re going to talk about how our current situation stacks up to years past. Then we are going to talk about the strange upsides of higher rates. And finally, we’re going to nail down the practical application of what it means for you, the roof over your head, and the decision to rent or buy. So let’s start with how rates compare to the past, because in order to know whether or not rates are high or not, now we need a historical benchmark. Let’s review our interest rate eras by hopping in our little time machine and boogieing back to the 1950s when people drove pink cars and went to diners for fun.

So the 1950s and 1960s painting with a broad brush, the fifties and sixties were mostly a time of economic expansion. In the aftermath of World War II, the Fed aka the Federal Reserve began to gently raise interest rates after a long depression period as the government began spending money on everything from infrastructure to social programs. This was also the era in which the 30 year fixed rate mortgage was born a feature of the US housing market that’s still not really found anywhere else on earth. While it was introduced for new homes in 1948, it wasn’t available for existing homes until 1954. And new homeowners rejoiced banks needed a little more convincing. Those with the Federal Housing Administration or FHA insured mortgages that provided extra protection for the banks as the lenders in case folks were not able to pay their mortgages. The invention of the 30 year fixed rate mortgage meant that you were paying for your home over 30 years rather than the old standard of 15, which meant that you had twice as much time to spread out your payments.

But as with all government intervention, that makes something more affordable in the short term, sometimes it has the unintended consequence of making things a little more expensive in the long term, more people can afford homes with 30 years to pay them off, and when more people can afford something for which supply stays the same, demand rises making it more expensive. But we’ll pick up that part of the story sometime in 2021. Between the 1950s and 1960s, the average interest rate was somewhere between 4% and 7%. But the data back then wasn’t super trustworthy. And thanks to Freddie Mac reporting, we started getting harder numbers for rates in 1971. So onto the 1970s, rates climbed in the 1970s, a period of stagflation, which is a unique economic phenomenon characterized by stagnant economic growth, high unemployment and high inflation.

Basically, imagine if 2022, which was a time of stagnant growth and high inflation, also had super high unemployment rather than a labor market tighter than a Skims body suit. Folks, it ain’t good. The chaos was in part attributed to an oil embargo that happened in 1973. So you may have heard people refer to the OPEC crisis and that drove the costs of goods and services sky high in response, interest rates climbed throughout the 1970s and peaked at a whopping 12.9%, but the worst was still yet to come in the 1980s. Throughout the 1970s though, the average was between 9 and 10%. We’ll get right back to the decades after a quick break.

All right, the 1980s. So if you thought 8% inflation was bad, can I interest you in 18%? Inflation was so out of control in the 1980s that rates were in the mid-teens. This is typically the period that people point to. When youngins today complain about high rates, they say, oh, back in my day rates were 12%. Now this is true except one big, except in the mid 1980s, the average home price was equivalent to roughly three and a half years of median household income.

Today in the post low interest rate environment, average home prices now equate to 6.4 years of median household income, and that is the skeleton key to this whole puzzle. But again, we’re getting ahead of ourselves. So where were we?

Oh, okay. Yes, the 1990s. The 1990s were a great time for a lot of reasons. We got things like Boy Meets World and the birth of Google and Yahoo and Henah’s favorite company, Amazon. Not to mention basically all of the pop culture that we are currently rebooting. The 1990s also saw a decline in interest rates. They dipped to around 6.5%. The housing market also saw rising rates of home ownership, increasing home values, and lots of construction streets are saying that your favorite podcaster was even born during this decade, and I am partial to 1994 myself, but we were in for a rocky decade to come.

The early 2000s were…What’s the industry term here? A shit storm for housing, and also low rise jeans. It was an absolute roller coaster. The subprime lending crisis and financialization of those bad loans teed up the global economy for a total meltdown. And in 2007, the House of Cards came tumbling down, taking property values with it. And if this all sounds like jargon to you, may I recommend watching the Big Short as your guide. The Global Financial Crisis or GFC was considered the worst financial crisis since the Great Depression, and it all started with a big bad housing bubble. So this meant many people who purchased their homes at the peak ended up underwater on their mortgages, which is what happens when you owe more on your home than it’s worth. So for example, I might’ve borrowed $400K for a $450K home in 2006, but then after the crash, the home was only worth $275K.

So now even if I were to sell the house, I cannot pay back that mortgage. It was an unthinkable, nightmare scenario and it was reality for many families.

So what were rates doing during this time? Well, they were mostly in the 5% ish range. And while I’ve read mixed perspectives on whether or not private equity is a large driver of our current woes, it is true that it’s during this period that large private equity firms started buying up single family homes by the thousands in regions where foreclosures were highest turning them into rental property empires. The estimates in the book Plunder: Private Equities Plan to Pillage America pegged the number in the millions of homes being snapped up by Blackstone, Carlisle Group, and others. But in the aftermath of the GFC, the economy needed a lot of help, which brings us to the 2010s.

So in the 2010s, rates pretty much fell steadily. We were facing slow economic recovery from the real bender. That was the early 2000s. And fortunately, we had low inflation too to, but this era was when the effects of zero interest rate policy or ZIRP really took hold, which meant interest rates were hitting record lows. And while we didn’t know it at the time, we were pulling back a slingshot that was preparing to unleash a lot of pent up demand to crush younger millennial and Gen Z dreams. But we also weren’t really building homes in this time period either, which was the other major plot point being set in motion and teeing up our current pain. Looking back at it, this was the “you don’t know what you have till it’s gone” era rates were roughly between 3% and 5% during this time. And that brings us to the 2020s.

A famously calm, unprecedented time because here we are in the 2020s suffering whiplash. The 30 year fixed rate mortgage averages hit their lowest rates ever in 2020 and 2021, falling below 3% for the first time, but they were short-lived because, oh boym did that spark an absolute Zillow fest. Every studio apartment dweller within 100 miles of a suburb promptly packed up and GTFO’ed trading walkability for a two-car garage and housing values popped in a dizzying game of real estate musical chairs. Suddenly it felt like stories about the housing market were inescapable. They were everywhere, and it was like we all finally noticed the slow burn of dwindling supply and years of underbuilding that had been in the works for the past decade, exacerbated of course by the pandemic distorting the economy and supply chains. And today as of 2024, rates are still historically average to low.

They’re just higher than they had been, and that feels like the biggest issue. Well, maybe not low, but let’s take a closer look, shall we? The St. Louis Federal Reserve (or FRED) has 2,750 interest rate data points for the 30 year fixed rate mortgage between 1971 and today the average interest rate over the last 50 something odd years is 7.73%. The median is 7.41%, and today’s interest rate is 6.99%. As of this recording still historically just about below the median, and although we’ve been accustomed to bottom of the barrel 3% bargains for the last few years, today’s rates, although generating a lot more interest over the loan term, wouldn’t really be deal breakers for buyers under normal circumstances. To put some bumper lanes around this calculation, imagine for a moment that you wanted to purchase the median home that costs roughly $430K with 20% down.

An interest rate of 7% would kick back a monthly mortgage payment of around $2,300 per month. At the now seemingly low 5%, you’d be looking at around $1,900 per month. And for some people that payment difference is a chasm. For others, $400 per month wouldn’t be a make or break amount when it comes to becoming a homeowner, especially since that payment is fixed. And higher rates have their upsides too. I mean, look no further than your favorite high yield savings account for proof. The ability to get a risk-free 5% on your liquid savings was unthinkable just a few years ago. And for those who are not in the market for a home, these rates are an absolute gift. And while many would be Zillow aspirants scroll their neighborhoods and wish for lower rates, be careful what you wish for. It’s probably not fair to say low rates caused the unaffordability crisis, but they were almost certainly a catalyst in driving up prices. Median sale prices rose sharply in 2020 after years of slow and modest growth, right as rates dipped below 3% for the first time. So remember how I mentioned that some government intervention designed to make things cheaper has the paradoxical effect of making them more expensive? Yeah, case in point. So I’m not really convinced personally that lower rates are going to save us from the predicament that we’re in, and we’re going to talk about why right after a quick break.

So let’s talk about housing affordability today…Because today’s interest rates aren’t really the problem. I would say it’s maybe more accurate to say that yesterday’s were, because the way I see it, it’s twofold. Abnormally low rates pushed up the prices of homes because people could afford to borrow more money, right? You remember our $2,300 a month versus $1,900 a month example, at 3% we’re talking just $1,400 a month. And unfortunately this has an unexpected second order effect, which is that people won’t move. According to Goldman Sachs, 72% of existing homeowners have an interest rate that is less than 4%. Now, some of this reticence to relocate is psychological. You feel like you snagged the last helicopter out of ‘Nam and taking out a new mortgage at 7% would be like jumping out of it without a parachute. But the other piece is practical. With the new interest rates and the higher prices, a lot of people would not be able to afford as much if they had to take out a new loan.

Part of the issue here is not that people who scooped up homes in 2020 and 2021 got those sweet, sweet low rates, but people who refinanced did too. Now, this is another unique function of the US’ 30 year fixed interest rate. Harvard economist John Campbell told the New York Times that the US mortgage market creates a sort of can’t lose one-sided bet for buyers. If inflation goes way up, the lenders lose and the borrowers win. And if inflation goes down, the borrower just refinances. In places where rates are only fixed for a few years, like Britain and Canada, the pain gets more evenly distributed. In Germany, for example, borrowers cannot easily refinance. And in that sense, US consumers who can swing it get a pretty incredible deal and swing it most can’t. Now affordability defined as the percentage of the median income one would need to spend to purchase the median home is at its lowest rate in 35 years, according to Black Knight, at 36.2%.

That is to say in order to afford the median home, you would have to spend more than one third of the median pre-tax income each month. And as you likely know about lending requirements, that is a non-starter. We’ve talked about this before on the show, but it’s this idea that this is the genie you cannot put back in the bottle. If one generation uses housing to get rich through myriad homeowner incentives and super low rates, it necessarily locks out the next and in some ways locks in the current. You can’t make that trick work twice. So as a result, everyone’s stuck hardly anybody’s happy unless you happen to buy your dream forever home a couple of years ago at 2.25% in which case you won lottery. Well, and maybe some renters are happy too because it’s now cheaper to rent than buy in 71% of the US’ major cities.

And make no mistake that says less about rent being cheap than it does about houses being expensive. This means a person who chooses to rent the median home and invest the difference in something like a low cost index fund will end up with net more money than someone who shells out the cash to purchase the median home with the average rate. Right now, and this is the beauty of the 21st century, it’s the ability to separate your need for shelter from your wealth building aspirations. But if you’re listening to The Money with Katie Show, you already knew that. So what if you do desperately want or need to own your own home for some reason? What should you do? Well, here’s the deal. We’ve already established that these rates are historically about average, but affordability as we can see is at a near historic low. So is there a perfect interest rate for you? Is there a point at which you should try to strike?

Well, for reasons we’ve reviewed, rates probably won’t soften too much, though there is some speculation that the Fed may begin cutting this quarter. But truth be told, I’m not even convinced we should want them to, given how much housing demand persists. And while prices have softened slightly since their peak in the fourth quarter of 2022, continued supply constraints suggests that we probably are not going to see a precipitous drop. But you shouldn’t buy a house because of an interest rate. You should buy a house because you want one and you can afford one. So how can you get a sense for how affordable or unaffordable owning is compared to renting in your current situation right now? If you’re moving somewhere and you intend to stick around there for at least 10 or so years, take a look at your cost of rent or expected rent for a year.

Now multiply that number by about 15, and if you could purchase a home that you would like to live in for that number or less, you should think about trying to buy that house. For example, if your current rent for a two bedroom is $3,000 per month, that is $36,000 per year. If you multiply that by 15, you get $540,000. Now, if you can afford the down payment, which is going to be around $100K and the payment of $3,600 per month inclusive of principal interest, taxes, and insurance, then that might be a worthwhile move. Now, this is because a price to rent ratio of 15 is considered the threshold below which buying will probably work out more favorably for you. But obviously simply knowing the general ratio for your area doesn’t really tell you if it works for your own preferences. Because if I run that calculation and I realize that my rent is $3K, but there actually aren’t any homes that I would’ve any interest in living in my area that cost less than $540,000, I have a better sense for how much higher my rent would need to get before buying would make sense.

So maybe the home that I would like to live in is $750K performing this math in reverse. We can find that as long as my rent is less than around $4,100 per month, I’m still probably better off renting and investing the difference. So what is a Rich Girl to do with that answer, if the answer is keep renting? Well, the way I see it, there are two important things to keep in mind right now. The first is that we all need shelter and we might need to be patient. There are different ways to consume shelter, as we’ve discussed on this show. You can rent it, you can buy it, which for most people is renting it from the bank for 30 years, or you can do both in a process called house hacking. Now, right now, the reality is that in three in four places in the US it is going to be net cheaper to rent, but it won’t always be.

These things are cyclical. And if you study housing price indices in the us, you can see that the price movement we’ve seen in the last three years has been highly abnormal and there’s quite a bit of recency bias powering or pessimism about the future because it’s easy to forget that we were just in relatively very affordable territory for about a decade after all between the end of World War II until the early aughts, US home prices appreciated by just 0.32% per year after inflation. In fact, practically all of the real growth in the housing index happened in the last couple of years. The three-year annualized returns are in a historical 11.49% and these types of cycles, they can last a long time. But I think we have reason to believe that prices will eventually reach more normal levels again, because that’s just part of how our economic system is designed to work.

Right now, there’s a lot of money to be made in building homes because demand is high and the government is aware that we need more housing. Now, those two things, profit making ability and government incentives are a pretty good recipe for making sure that more homes get built. The answer to this dilemma is more supply and increasing supply takes time. Housing starts the metric that tells us how many new residential projects are underway are generally headed in the right direction after years of decline post 2008. Now, this type of new supply creation of everything from affordable housing for low-income families to dense urban multifamily projects to larger three and four bedroom single family houses is paramount and it’s often solved at the local level. We don’t really have one monolithic national housing market. We have a lot of regional ones, and that’s where NIMBYism comes in.

Restrictive zoning that blocks things like multifamily development and makes it more challenging to build. We’re not going to spend too much time on NIMBYs today, but if you care about housing in your community, it might be worthwhile to get involved down at City Hall to understand who is making these types of decisions and what types of votes are being held on zoning and new construction that determine when and where new projects can be built. Your local city council probably meets regularly to talk about these things, and you might get a better insight into that decision-making process. Many cities have boards and commissions that focus on things like planning and zoning, and these often do have citizen members personal letters and emails to local representatives can be an effective place to start too. So all that to say, while it’s unlikely that nominal prices will drop precipitously at the national level, my prediction is that growth moving forward will be something closer to normal and incomes will continue rising, such that the debt to income ratio is more in line with historical norms of around 25% of monthly income as opposed to closer to 40%, which is where it’s now.

Now I have no crystal ball, obviously, of course, but if I were a betting woman, that’s how I would assume things are going to play out. So all that to say patience might be the key virtue here. I know that’s not a sexy answer, but I feel in my gut it is the most accurate one. And in the meantime, rent within your means. Which brings me to point number two. If you have a goal to buy a home soon, you probably shouldn’t rent at the top of your affordability threshold. I was speaking with a CFP named Katy Song the other day, and she offhandedly mentioned this client that she has in DC. Now, this person was interested in buying her first home, but she was also renting a luxury apartment in Washington, DC, and Katy broke down the numbers for her and showed her that renting the most expensive apartment she could afford had a serious financial impact on the progress she was making toward homeownership.

If she chose an apartment that was a little more affordable for the short term, she was going to have her gold down payment a full year ahead of schedule. Now, these types of trade-offs happen all the time financially, but this one can be difficult. When we feel stuck between a rock and a rented hard place, it’s like if we have to rent, we think we might as well rent the nicest place we can get, and it becomes a catch-22 for obvious reasons. We rent the super nice place as the consolation prize for not being able to buy, but then renting the super nice place makes it that much harder to, you guessed it, buy some people. When faced with this dilemma, experienced clarity that actually living in a nice place is more important to me than owning the place that I live and the pressure and desire subsides a little.

Others might realize that they would rather downsize their apartment or their rental home so that they can save even faster. The point is, if your goal is to buy a home within the next year or two, you might want to consider finding ways to shrink your housing costs in the meantime, like moving into a less luxurious building if you’re in really fancy digs now or getting roommates or downsizing the size of your home. But the point is there are options. And finally, I guess I think about this dilemma a little differently. So never heard someone talk about how they weren’t looking when they found their soulmate. That’s a little bit how I feel about owning a home, and I’m not sure why, but I’m a little indifferent. I like living in nice places, don’t get me wrong, but it doesn’t really matter to me whether I’m renting them from another individual or from the bank and the city in the form of a mortgage and property taxes.

In that sense, I don’t currently have an emotionally fueled desire to be a homeowner, and I figure I will become one someday when the price and the opportunity is right. But I guess I think it’s going to be a little bit like that soulmate scenario. It’s like, oh, when you know you’re not, and for that reason, I guess patience does come a little more easily to me, which makes it maybe easier said than done as a general recommendation. But for me at least, it helps me when I see other successful people, especially people who already have children renting their primary residence. I recently stayed in a friend’s house in Mill Valley, California, which is a notoriously expensive, very hilly, beautiful majestic suburb of San Francisco in Marin County, and they have two children and they rent their house simply because it is just far more economical there to do so.

And I can assure you that their home was no less warm, lovely, or surrounded by nature and community because it was rented instead of owned. So yes, while the market might be frozen right now because of higher rates and high prices, I think the thaw is already beginning because whether people end up needing to move for reasons outside of their control, or a generation of homeowners gets older and eventually passes on, or our supply catches up the demand, I do believe normalcy will eventually be restored. And if the post pandemic recovery taught us anything, I think it’s that those returns to normalcy often happen a lot faster than any of us expect. So keep saving and stay ready.

That’s all for this week. I will see you next week, same time, same place on The Money with Katie Show. Our show is a production of Morning Brew and is produced by Henah Velez and me, Katie Gatti Tassin with our audio engineering and sound design from Nick Torres. Devin Emery is our chief content Officer, and additional fact checking comes from Kate Brandt.