A unique mortgage system may make the U.S. more resilient to price decreases
Quick Takes:
- As of November 22, 2022, other countries are experiencing post-boom corrections that are more pronounced than in the U.S.
- During the pandemic, there was an unprecedented boom in real estate worldwide.
- The 30-year fixed-rate mortgage is a unique product of the U.S. and may make the U.S. price correction stickier than in other countries.
Home prices are sinking worldwide. At the end of September, home prices in New Zealand had fallen over 6% since their peak. Canada and Australia had similar declines of 5.5% and 4.8%, respectively. Growth has reversed in the U.S. too, but the drop is still less than 2% from the peak.
Figure 1: Home Price Indexes, Jan 20 – Sep 22: United States, Canada, New Zealand and Australia
Figure 2: Current, Peak and Decline from Peak Appreciation, Jan 20 - Sep 22: United States, Canada, New Zealand and Australia[1]
Perhaps the declines in Oceania and Canada portend a drop in U.S. prices. Figures 1 and 2 show that the experiences of all tracked countries’ housing markets have been similar. All four countries experienced huge price growth since the beginning of the pandemic, and all four saw prices plateau in the first half of 2022.
New Zealand had the biggest boom with prices rising 46% since January 2020; the U.S. and Canada closely followed with 41% and 38% increases, respectively. Australian prices rose 28% during the same time period.
Additionally, all four countries are experiencing high inflation that has led to sharp interest rate increases from their central banks. The rate increases combined with home price growth have caused the standard mortgage payment in each country to balloon. The reduction in buying power should create declines in demand within each country. Figure 1 shows the U.S. was the last market where prices began to decline, an indication that it is on a similar path to the other three countries.
However, for sellers, things are potentially different, and U.S. homes may prove to be “sticky” on the downturn when compared with the other countries. This is because the U.S. mortgage market is unique.
In the United States, mortgages are securitized, meaning that banks do not directly bear the risk of mortgages but rather sell them to government-sponsored enterprises (GSE) like Fannie Mae and Freddie Mac, which package the mortgages into mortgage-backed securities. This allows banks to extend more favorable loans to borrowers for longer periods — this generally takes the form of a 30-year fixed-rate mortgage — with no prepayment penalties and the option to refinance the loan at any time if rates change.
As a result of this system, nearly all borrowers in the United States are locked into mortgages with rates at around 3% for the life of the mortgage. Overseas borrowers do not have the same luxury since banks hold the mortgages they sell, and thus directly bear the risk, rather than passing it onto an entity like the GSEs. However, mortgages have similar lengthy terms of 20 years or more, but since the rate is not fixed, it is adjusted every few years[2]. In New Zealand for example, over half of the outstanding mortgages will have their rates changed in 2022.
The availability of long-term, fixed-rate mortgages for U.S. borrowers means that homeowners are disincentivized to move since it requires them to give up their current rate, which has the potential of putting people in substantially worse financial positions. Unsurprisingly, U.S. inventory remains very low, and the supply-demand balance becomes skewed. With such market conditions defining the U.S., the country may end up showing comparative resilience to price drops, and the housing market downturn should show itself more clearly in sales declines.
Tim Lawless provided the Australian data and Nick Goodall provided the New Zealand data.
[1] Australia’s peak was in April 2022, Canada’s in April 2022, New Zealand’s in March 2022 and the United States in June 2022.
[2] Prepayment penalties are also standard.
