Why Lower Interest Rates Haven’t Made Buying A Home More Affordable

Striving to move up the housing ladder is a fundamental aspect of the American Dream, but the lack of wage growth over the past year has been a significant hurdle for millions of Americans.

New home sales unexpectedly fell for the third straight month in December, dropping by 0.4%, according to the Commerce Department (economists polled by Reuters expected new home sales to rise 1.5%).

When central banks cut interest rates, it typically encourages people to buy houses, since it makes mortgages more affordable and stimulates demand to build new homes. The Fed cut rates three times in 2019, and held rates steady in its first policy-setting meeting of 2020, keeping rates in the current target range of 1.50% to 1.75%.

So why aren’t lower rates – mortgage rates have been hovering at around 3.7% – boosting new home sales?

Home prices keep rising

Wages have remained relatively flat for most workers, with the pace of hourly wage growth sliding below 3% in December for the first time since July 2018. Yet the price of new homes remains elevated with the median price for a new home climbing to $331,400, up 0.5% from a year ago. A shortage of homes on the market has also served to keep home prices high. (The U.S. housing market is short 3.8 million new homes, according to a new Realtor.com analysis.)

Many Americans who can’t afford to buy a home are sticking to renting. “We’ve seen an incredible amount of demand for apartments and rentals as people have gotten burned from home price losses from back in 2008, 2009,” Hessam Nadji, CEO of Marcus & Millichap, told Yahoo Finance.

“And the new generation wants to be more flexible and more mobile. They prefer to rent. All of our apartment investors have benefitted from that across the country,” he said.

Trump’s tax law reduced home buying incentive

The 2017 Tax Cuts and Jobs Act reduced the amount homeowners can deduct from interest paid on their mortgages to up to $750,000 worth of principal, making the tax break for owning a home less compelling.

“A young couple or single adult professional that may have gotten a tax break by buying a home, now really doesn’t need that tax break as much because the tax law changed. They’re more likely to stay in a rental apartment,” said Nadji. “And the same thing with middle class, or midtier homeowner that would have normally stepped up to the next pricing tier and the deductibility above $1 million of mortgage, of course, went way down.”

Low interest rates, though, have provided a small boost to sales of existing homes, which represent about 90% of U.S. home sales. Previously owned home sales jumped 10% year-over-year in December.

“New homes are naturally more expensive than existing homes and so affordability becomes even a bigger factor,” said Nadji, adding, “especially as people stay in their rental housing longer which is what they’re doing and are less incentivized to buy new homes than they have been in other cycles.”

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