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Mortgage rates are rising. Will that slow our out-of-control housing market?

(Los Angeles Times photo illustration / Unsplash photo)
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For a decade, rock bottom mortgage rates helped home buyers steadily bid up the cost of housing. That includes the last few years, during the pandemic, when rates fell to unheard-of levels and home prices exploded across Southern California and the nation.

Now, things are changing.

Mortgage interest rates are rising fast, hitting 5% last week for the first time since 2011, according to a widely watched gauge from Freddie Mac. Just six weeks ago, average rates for a 30-year fixed mortgage were under 4%. In November, they were below 3%.

The swift rise, on top of soaring prices, has made homeownership suddenly more expensive. So, if people can afford less, are home prices about to fall?

Several top real estate experts said they don’t foresee price declines — at least meaningful ones — absent a recession. Prices are most likely going to continue to climb, but in smaller increments than Southern California’s current 17% annual rate.

A mortgage will be the largest sum of money you ever borrow. How do you find a good lender? What is a conforming loan? What’s a rate lock? We explain.

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Economists and other experts pointed to several factors that should largely uphold home values: a severe shortage of homes for sale, rising incomes, falling unemployment and — in plain language — a tendency for homeowners to be greedy.

“A lot of times people go, ‘Well, if I can’t get the price my neighbor got, I am not going to sell,’” said Bill McBride, author of the financial blog Calculated Risk who famously called the housing crash two decades ago.

In the past, sharp rises in mortgage rates have slowed home price growth,and experts said higher rates should have the same effect this time around as well.

The simple reason is people can afford less, and this is starting to show. Industry professionals report fewer people at open houses, fewer multiple offers per home and fewer mortgage applications.

“It’s cooled quite significantly,” said John Underwood, who manages a team of Redfin agents in the San Fernando, San Gabriel and Conejo valleys.

While it’s still solidly a sellers’ market, Underwood said houses that just a few months ago might have gotten 15 or 20 offers now get five or six. It’s become harder for sellers to make special demands, including that prospective buyers waive loan and appraisal contingencies that let buyers back out if a problem arises.

Most people don’t buy a home with a 20% down payment. Here’s how you can put down less and get more help with down payment and closing costs.

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Agent Randy Conrad, who works throughout L.A. County, said he’s seen a few deals fall out of escrow because buyers didn’t lock their rates and could no longer afford the home when borrowing costs jumped.

Cooling demand hasn’t yet translated into a slowdown in what homes are selling for, according to the latest available data.

The median home price across the six-county Southern California region rose 16.7% in March from a year earlier, to $735,000, according to data published Wednesday by the research firm DQNews.

That’s slightly faster than the 15.4% year-over-year gain posted in February. In Orange County, the March median price soared 22% and topped $1 million, the first time the median price in any Southern California county has crossed the million-dollar mark.

Use this calculator to get an idea of how much you can borrow, and explore which ZIP codes have a typical home price that will fit your budget.

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The March data reflect closed sales; many of those buyers opened escrow in February, when rates were rising but were still more than a percentage point below rates today. A more up-to-date view on the direction of the market can come from looking at price cuts.

Michael Simonsen, founder of Altos Research, said that the number of sellers trimming their asking prices is still way less than normal. But price cuts are becoming more common at a time of the year when they usually decline or don’t rise much at all.

In the city of Los Angeles, 17.5% of listings had a price cut as of April 8, up from 14% on March 11, according to Altos figures.

“Last year, when the market was hot, [price cuts] were declining notably week over week,” Simonsen said.

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‘Piles of cash’

Price cuts could translate into a decline in actual home values, eventually, if wide swaths of people stop being able to afford today’s prices and sellers adjust their expectations — a possibility that becomes more likely as rates head higher.

Take the current Southern California median-priced home, at $735,000.

Assuming a buyer puts down 20% to buy a $735,000 house, the monthly mortgage payment — including property tax and insurance — would be $3,450 if the interest rate was 3.22%, the average at the beginning of the year.

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At last week’s average mortgage rate of 5%, that monthly payment would be $4,045 — an increase of $595 a month, according to a Redfin mortgage calculator.

Before starting your home buying search, experts say you should figure out much you can borrow — and whether a smaller mortgage would be wiser.

For a $1-million house — a price point that became much more common around the L.A. region during the pandemic — the higher rate adds $827 a month. Compared with the below-3% rates in November, that represents an increase of nearly $1,000.

Given the long run-up in home values, many homeowners have lots of equity, and they could sell for less than what their neighbor sold for last year and still make gobs of money.

But homeowners often have a number in their head — their sales threshold — based off of recent area sales. And if they don’t need to move, they are reluctant to sell for less, agents and experts said.

Some might even have a below-3% mortgage and are reluctant to ditch it to buy another house at a higher rate.

The reason home prices declined as much as they did when the early 2000s housing bubble popped was because a wave of forced selling — through foreclosures and short sales — brought down the entire market.

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Although the economy is humming, some analysts say that today’s rising inflation could trigger tomorrow’s recession. But what is a recession, and what can you do to prepare?

This time around, loan underwriting has been far stricter, with less-exotic debt structures, leaving owners less vulnerable to changes in personal or macroeconomic conditions such as job loss or rising rates.

That means even in the case of a recession, there would be fewer forced sales and smaller price declines, said Ralph McLaughlin, chief economist with real estate data firm Kukun.

In today’s environment, price declines would probably need to follow at least two years of rising inventory and falling sales, according to Logan Mohtashami, lead analyst for the trade publication HousingWire.

That’s a long ways off.

As the spring home buying season kicks off, more homes are coming on the market, but in March there were still 31% fewer homes for sale across Los Angeles and Orange counties than a year earlier, according to Zillow data.

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The people who want those homes didn’t disappear once rates hit 5%. Millennials are currently the biggest generation and a large cohort are in their late 20s and early 30s, which is when many people buy their first home.

Mohtashami said there has never been more Americans ages 28 to 34, creating a “once in a lifetime event” underpinning home buying demand through 2024.

Many Americans — millennials or not — have also seen their wealth grow during the pandemic, a result of a booming stock market, rising home equity, government relief and less money being spent on restaurants and travel.

“There is just piles and piles of cash,” said Christopher Thornberg, founding partner with Beacon Economics, who said people can use that stockpile to offset higher borrowing costs through larger down payments.

Buying a home for the first time is one of life’s sweet milestones.

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McLaughlin said that if rates stay around 5%, he would expect the rate of price growth to be cut in half in three months.

Southern California home prices might fall 1% or 2% on an annual basis if rates rose to 7% or 8%, McLaughlin said. But for prices to fall meaningfully — 4% or more — he said it may take not only 7% rates at a minimum but also an economic downturn and a restrained government response in which Washington doesn’t step in quickly to help homeowners avoid foreclosures, as it did throughout the pandemic.

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Bad news

For those looking to buy a home later this year or next, will higher rates automatically mean the monthly mortgage payment will be higher than if rates stayed low?

That’s a question without an easy answer.

But for those looking now, it’s more expensive. McLaughlin said higher rates will probably be “very, very bad news” for people who barely qualified for a loan, since higher borrowing costs may very well knock them out of the market.

For others who have more wiggle room, it could open up more opportunities if inventory rises.

“They may be more content in the home that they find even if they have to pay a higher mortgage rate and a higher monthly payment,” McLaughlin said.

Keller Williams agent Amber Dolle got a real-time taste of the changing market two weekends ago when she held an open house for a Valencia three-bedroom townhome priced at $680,000.

She said attendance was about half what it would’ve been last year, with 35 prospective buyers coming in.

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The number of offers was also less than Dolle would have expected last year, but there were still six of them and all were over the asking price, showing how even a reduced number of buyers can easily send prices up when there are so few homes for sale.

Bidding wars and supply shortages have driven prices to historic highs. Here are five homes listed below the L.A. County median home price.

That’s why Mohtashami said he’s rooting for mortgage rates to stay high for a prolonged period to bring more balance to the market.

In 2018, mortgage rates neared 5% and home price growth proceeded to slow dramatically. In March 2019, the Southern California median price even dipped 0.4% from a year earlier, the first decline since 2012, according to DQNews.

But after that dip, home prices started their upward march once again, helped by mortgage rates that then fell below 4%.

“The fear that I have is mortgage rates peak out around here ... and mortgage rates go back down,” Mohtashami said of the current market. “Higher rates are the only thing that can put home sellers, home builders and home investors on their ass.”

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“They have way too much pricing power as a collective whole and look what they are doing: They are all pushing it to the limit.”

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