What Historically Low Mortgage Rates May Spell for Homebuyers in 2020 and Beyond

The interest rates set by the Federal Reserve Bank affect the price of housing and consumer goods in ways that dwarf actions by the U.S. Congress and the president. Low interest rates reduce mortgage costs, encourage home sales, stabilize or increase home values, and generally push the consumption of goods and services.

Compared to the relatively marginal grants and loans allocated by elected representatives to carry out public interest goals, the Fed’s actions are many times more powerful, mobilizing trillions of dollars in capital. Cutting borrowing costs lessens the impact of crises, but the consequences can be contradictory—and risky—in the long run, encouraging borrowing that depends on nonstop increases in prices and economic growth.

The Fed has set rates near zero twice during the last two decades in response to economic crises—first, during an extended period from 2008 to 2015 after the mortgage-backed securities collapse, and again this past March in response to the epic Wall Street crash at the start of the pandemic. In both cases, zero interest rates have been accompanied by "quantitative easing" on the part of the central bank, which essentially printed new cash to increase the money supply and encourage banks to continue lending. This time, officials expect interest rates to remain near zero through at least 2023.

During the last recession, the Fed purchased $3.83 trillion in assets (most of which was government debt in the form of bonds), and it has acquired another $2.7 trillion since March. Normally, this increase in the supply of dollars should decrease their value and increase inflation. But so far, the act has had only slightly weakened the dollar against the British pound. The dollar remains the world’s "reserve" currency: a safe haven considered stable and reliable as a place to store capital. That impression is reinforced by a high level of coordination with the European Central Bank, and by China’s desire to keep its currency low to maintain exports.

A long-term risk of low interest rates is that low borrowing costs artificially push up the real estate market over time in a way that adversely affects affordability compared to wages.

This was the result in 2008: Interest rates had dropped to less than 1% in 2003 to recover from the dot-com bubble (and subsequent crash) and the 2001 recession. Asset prices climbed, leading to the famous "irrational exuberance" of the mid-2000s stock market. Once the lending rates returned to a more normal level, it resulted in massive defaults and foreclosures on the part of over-leveraged property owners unable to withstand increases in monthly payments. 

"Obviously, there is somewhat of a tension between one group seeking for housing to be affordable, which means low prices, and another group seeking continuing investment return, which requires not just high prices but continually increasing prices," says Peter Gowan, policy associate at the policy and advocacy organization The Democracy Collaborative. "I’m not very sympathetic to the idea that the primary purpose of housing—and the primary purpose of what public policy should do in regard to housing—should be to deliver investment returns to people over time." 

Increases in home prices also tend to increase homelessness, especially in major cities like New York, San Francisco, and Los Angeles, where inflationary property values encourage development and create an incentive for rental property owners to not renew leases, renovate, and sell at the current market rate. Tenants looking for new apartments in tight housing markets with low vacancy rates may find prices for available apartments have doubled at the new market level. In 2019, the U.S. had more than 500,000 people in shelters or on the street, and schools reported more than 1.3 million homeless students.

"I don’t think that we can—or necessarily should—stop the market building housing right now: I wouldn’t go as far as that at all," says Gowan, who mentions social housing, limited equity co-ops, and community land trusts as models that can be scaled up and given more access to capital through public financing and public banking.

"But I do think we need to stop our overwhelming reliance on leveraging private capital for our entire housing stock," he continues. "It’s not going to be sustainable for us in the long run. It’s always going to prioritize profits over other social motives. To the extent that we can get them to do anything else, it’s always going to be through the government subsidizing it, which brings us back to the question: Can we do it in a more controlled and scalable way by having the government build up its capacity to do these things?"

Low-interest mortgages also affect the liquidity of housing for city dwellers considering moving within the city, to the suburbs, or into the country. High prices encourage borrowers to take out larger loans relative to home values and their own income, making it more difficult to sell property when substantial decreases in sales and prices are occurring in some markets. 

Some economists argue there should be constraints on credit markets limiting loan-to-value and price-to-income ratios for borrowers, but that would also prevent low-income households from having access to credit. Taxing second and third homes at much higher rates would also reduce speculation. In New York City, they still do the opposite, offering significantly reduced taxes to non-primary residences—a legacy of the 1970s-era policies meant to stimulate investment which has only encouraged extreme bets on ever-increasing prices by anonymous limited liability corporations and international buyers.

"Home is not meant to be a speculative financial asset—it’s supposed to be something that we fundamentally live in, and everybody should have a right to that," says Frank van Lerven, senior economist at the London-based New Economics Foundation. He points out that the Federal Reserve could easily lend substantial sums to public banks—the money could be used to fund social housing and other infrastructure, and the debt could then be sold to the private sector, just like other government debt, to reduce risk.

"Home is not meant to be a speculative financial asset—it’s supposed to be something that we fundamentally live in, and everybody should have a right to that."

—Frank van Lerven, New Economics Foundation

"You can still make the case also that you don’t need these different quantitative easings, but interest rates are fundamentally low, and in a low-interest-rate environment, the government could borrow to build new homes if it wanted to and invest much more through that route," he says. "The government has access to extreme low interest rates, where an individual perhaps doesn’t. The government might be better placed to help pass the low interest rate that it has access to onto those with underprivileged backgrounds by using its borrowing power to sell at a lower rate—or just rent."

In Manhattan, housing sales have dropped 54% and median prices have fallen 17.7% since the pandemic started—the largest drop in 30 years. After a steep fall in the spring, San Francisco sales and prices recovered this summer, and Los Angeles prices are also up slightly across the region from the same time last year after a drop in the spring.

In Houston, so-called "pandemic buyers" are reportedly searching for new homes after experiencing less-than-ideal quarantine conditions—the city recorded an 18.3% sales increase in June compared to last year, and a 3.6% increase in prices. Denver set price records in July, with a 12.5% growth in sales and a 9.9% increase in values since this time last year. Meanwhile, Detroit had a 4.6% increase in prices across the metro area—but a 27% year-on-year decrease in sales.

With 30 million Americans out of work, and the U.S. economy having declined by 5.9%, low interest rates may be only putting off an inevitable decline in home values. Unemployed workers may marginally keep up with payments while receiving jobless benefits, but uncertainty remains over what will happen with the lapse in benefits as personal savings run out.

Low interest rates may be only putting off an inevitable decline in home values.

Until recently, there had been a nationwide eviction moratorium, but evictions reportedly returned in August during a lapse in congressional action, and the recent executive order will be uneven in its effects. The pandemic is likely to drag into a second year, and many economists doubt hiring will rebound to the same level.

If Congress takes other actions to prevent foreclosures, such as cancelling payments owed to banks during the health emergency, it may prevent lenders from seizing homes, home prices from falling, and abandonment due to underwater mortgages. But if a crash in securities again freezes the monetary system, Congress and the Fed may well follow the script from the subprime loan crisis, capitalize the banks, and let homeowners take the losses.

Related Reading:

How Is the Pandemic Changing the Housing Market?

What Happens When Eviction Moratoriums Expire?

Is the Pandemic Priming Neighborhoods for a New Wave of Gentrification?