This is why mortgage rates of 7% for buyers are so much worse today than they were 20 years ago

Mortgage rates haven’t been this high in over two decades, but it’s far worse to buy a home today than it was then.

Buyers are still shocked by memories of historically low interest rates when they could afford so much more two years ago. Those still looking in today’s market are facing a major inventory shortage as many homeowners keep their properties off the market. That just drove real estate prices skyrocketing.

Add in high inflation and decades of stagnant wage growth, and shoppers today have less purchasing power than they did twenty years ago, leading to a deep affordability crisis as interest rates rise.

“Over time, that can have a significant impact, as we’ve seen over the last few decades,” Andy Walden, Black Knight’s vice president of corporate research and strategy, told Yahoo Finance. “The market is much more reliant on a low interest rate environment to support current house price levels than it has been in the past.”

Mortgage rates: now and then

According to Freddie Mac, the average interest rate on the 30-year fixed-rate mortgage was 7.18% last week after rising to 7.24% the week before. This was the third consecutive week that the rate exceeded 7%, the first time since April 2002.

“Even though mortgage rates were over 7% then, they’ve been around 7% for most of the previous decade,” Len Kiefer, deputy chief economist at Freddie Mac, told Yahoo Finance. “The market was very different.”

Interest rates actually averaged 7.66% between 1992 and April 2002, according to data from Freddie Mac. They then began to decline, averaging 6.03% until mid-2006, when the housing bubble peaked.

“The Federal Reserve was concerned about the possibility of deflation,” Kiefer said of the early 2000s. “The core PCE price index increased by only 1.4% from March 2001 to March 2002. Given the current economic climate, the Federal Reserve is concerned about inflation as the core PCE price index is up 4.1% year-on-year.”

The story goes on

Today’s homebuyers couldn’t have a more different experience as the Fed has been raising interest rates rapidly over the past 18 months. Mortgage rates followed, but only after buyers had seen them fall below 3% for more than a year during the pandemic, sparking a riot among buyers and a refinancing boom among homeowners.

Read more: What the Fed’s latest rate hike plan means for mortgage rates and lending

At the end of this record low, almost no one had a mortgage rate above 6%. In fact, as of June, 91.8% of US homeowners had a mortgage with an interest rate below 6%. Redfin found. Additionally, 82.4% of homeowners have a mortgage rate below 5% and 62% have an interest rate below 4%.

“It all depends on how homebuyers — and by extension, home prices — behave in an environment of falling interest rates, as we’ve seen broadly over the past 40 years,” Walden said.

Supply and demand: every now and then

Now, all those homeowners with a low mortgage rate don’t want to sell and give up, leading to this so-called lock-in effect.

This led to historically low inventories on the resale side and declining sales. What’s left in the market is “old, tired stock,” Toll Brothers CEO Douglas Yearley said at the company’s earnings announcement last month.

Instead, buyers who are still looking are flocking to the new home market and driving sales there. The builders reacted by expanding the construction work, but this was not sufficient to compensate for the housing shortage.

Demand remains solid but volatile.

The millennial generation – now the largest generation – has entered the prime of starting and buying homes, but modest hikes in mortgage rates are putting many of them out of the running. The number of applications to buy a home has declined as rates have been above 7%.

“It’s a very interesting picture right now,” Jessica Lautz, deputy chief economist for the National Association of Realtors, recently told Yahoo Finance Live (video above). “We have a high demand for housing. There are many consumers who are waiting. However, interest rates continue to rise.”

Two decades ago the picture was different.

While the economy slipped into an eight-month recession from March 2001, retail sales and housing construction were spared the impact for much of the year, one said Bureau of Economic Analysis 2002 report on the labor market in 2001. Consumer confidence only began to wane in the second half of the year following the September 11, 2001 terrorist attacks and rising unemployment.

“Falling mortgage rates and resilient consumer confidence supported housing construction, at least until mid-year,” the report said. “Existing home and new home sales in 2001 were much the same as the previous two years and employment in the real estate sector followed this flat trend.”

In fact, the number of single-family home launches, new home sales, and existing home sales were all higher than they are now.

The volume of mortgage applications for purchases also continued to increase in the early 2000s, a sign of stable demand and the opposite of what is happening today.

“Rising home values ​​reinforced the investment aspect of home buying, in stark contrast to falling stock prices,” says the BLS report.

Real estate prices: every now and then

In both eras, real estate prices increased significantly. But the recent surge has surpassed that of two decades ago.

As mortgage rates hit historic lows during the pandemic, buyers who had access to cheap financing pushed prices higher. According to the S&P Case-Shiller national home price index, prices rose 45.15% between January 2020 and the all-time high in June 2022.

Buyers “inflated their budgets and increased competition in the market, causing house prices to rise much faster than incomes because buyers can use the same income to buy an even more expensive home,” Walden said.

Although prices fell for seven months last year as buyers balked at higher mortgage rates, they have started to recover this year and are still 45.12% higher than in January 2020 – just below their all-time high.

Property prices also rose 20 years ago, but not at quite the same pace.

The change in home values ​​between January 2000 and June 2002 was 22.3%, or about half the rate of growth recorded by buyers over a similar 18-month period between pre-pandemic times and the peak in 2022. From January 2000 to June 2003, prices increased by 33.23%, less than the same period in the 2020s.

“Although the average price of existing single-family homes continued to rise, affordability also increased thanks to moderate mortgage rates,” the BLS report said.

Affordability: now and then

The biggest difference between now and then might be affordability.

In April 2002, it took 27% of the average household income to pay the mortgage payment to buy a house at an average price. That’s slightly below the 1975 average of 27.76%, according to figures from mortgage technology and data provider Black Knight.

In comparison, today’s buyers spend 38.30% of median household income to buy a home at the median price.

Another way to look at this is to measure the median home price to median income ratio.

From 1975 to 2000, the median home price averaged 3.6 times the median household income. Today, that’s up 5.9 times median earnings — slightly down from the six levels it hit last summer before prices began to correct, Walden said.

“The last time interest rates were at these levels, home prices, which have risen 160% over that period, have risen twice as fast as incomes, which have risen just 80% over that period,” Walden said.

“It all works fine until interest rates go up sharply, which means you can’t use the same income dollars as you have in recent years,” he said, “causing a significant cost hit.”

gabrella is a personal finance and housing reporter at Yahoo Finance. Follow her on Twitter @__gabriellacruz.

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