What the interest rate hike means for homebuyers

A difficult year for many homebuyers became even tougher when the Federal Reserve dramatically raised borrowing costs this week in an effort to tame sky-high inflation, experts told ABC News.

For months, homebuyers have faced the dual challenges of skyrocketing mortgage rates and continued growth in home prices.

Since mid-March, when the Federal Reserve instituted its first rate hike of the year, the average 30-year, fixed-rate mortgage has jumped from 4.45% to 6.11%, according to Mortgage News Daily. Meanwhile, the median price for existing single-family homes rose 15.7% over the first three months of 2022 compared with the same period last year, according to data from the National Association of Realtors.

The Fed's decision on Wednesday to raise interest rates by 0.75%, its largest hike since 1994, will further increase mortgage rates and push many homebuyers out of the market, slowing home price increases but intensifying demand in the rental market, experts said.

"It's got a huge impact," Mark Stapp, a professor of real estate at Arizona State University, told ABC News. "It's going to bump a lot of people out of homebuying."

To be sure, rates for 30-year, fixed-rate mortgages do not move in direct correlation with the Fed's benchmark interest rate. Instead, mortgage rates trace the ups and downs of the yield on 10-year Treasury bonds, which responds to a host of indicators such as inflation and the outlook for the economy as well as interest rates.

Over the past week, as new inflation data showed a reacceleration of price hikes and observers expected the Federal Reserve to escalate its fight to dial back cost increases, mortgage rates increased more than they have over any week since 1987, according to a Freddie Mac survey released on Thursday.

Steep mortgage rate increases significantly elevate the monthly cost of homes, shutting out many buyers, decreasing overall demand, and affording leverage to the buyers who remain, experts said.

Mortgage rates will continue to increase at least moderately and could reach as high as 7%, some experts said.

"A month ago, I would've thought that 7% would be outlandish and it would be delusional to think they could go that high," ​​Holden Lewis, a housing expert at personal-finance site NerdWallet, told ABC News. "Now I think okay, well, 7% might be possible."

"Every time I think they'll stop, they keep going up," he added.

At the outset of the year, when the rate for a 30-year fixed mortgage stood at 3.25%, buyers who could afford a $1,500 per month spend on the home principal plus interest, could borrow enough to afford a $345,000 home, Lewis said. At the current rate, roughly 6%, the same homebuyers can borrow about $250,000, reducing borrowing capacity by about $95,000, he added.

"As mortgage rates increase, the monthly payment you can afford can buy less house," he said.

The mortgage rate hikes disproportionately impact buyers on the fringe of the housing market, such as people seeking their first home, said D. Sam Chandan, a professor of finance and director of the Center for Real Estate Finance at New York University's Stern School of Business.

"We've seen a significant deterioration in housing affordability over the course of this year," he said. "In particular for the aspirational first-time home buyer in many markets around the country."

Forecasters expect a decline in home purchases this year, which should slow price increases, experts said. Total home sales are expected to drop 13.5% to 5.96 million units in 2022, according to Fannie Mae data released this month.

But the supply of homes will also likely decline, as sellers wait for a more favorable market, moderating the price relief expected from waning demand, Chandan said. Further, declining interest in the market for home purchases will spike demand and potentially raise prices in the rental market, he added.

In the short term, a possible rental price hike would coincide with a persistent rise in prices for essentials like fuel and groceries, straining household budgets, Chandan said.

"We find ourselves in a place where apartment rents are increasing faster than many families' incomes are growing," he said. "The deterioration in affordability for many income-constrained families is forcing a very tough choice in having to spend less on education, clothing, healthcare and food in order to pay rent."