Are We Headed For A Housing Market Crash?

Covid caused a lot of things to slow – but not the global housing market. Consumers emerged from lockdowns flush with savings and looking for bigger, better work-from-home spaces. And mortgage rates at invitingly low levels helped fuel a home-buying frenzy. Now, though, rising interest rates and red-hot inflation have made homes and mortgages less affordable, increasing the risk of a crash in the global housing market, particularly in certain countries, and threatening to worsen a worldwide economic downturn.

What’s happening with the housing market?

Demand for housing is waning as mortgage rates increase, making homes less affordable, and causing potential buyers to pull away from the market.

There are two main reasons why mortgages have become significantly less affordable this year. First, skyrocketing inflation has led to a sharp fall in people’s real incomes. Second, central banks all over the world are raising interest rates at the fastest pace in decades. That directly increases mortgage rates, making it more expensive to borrow to buy a home.

These issues impact not only would-be homebuyers, but also existing homeowners, especially those whose mortgages aren’t locked in for the long run at ultra-low rates. Millions of people borrowed cheaply to buy homes at record prices during the pandemic boom, and many of them will suddenly face bigger monthly payments as their loans reset to reflect higher interest rates. Making matters worse is that those bigger mortgage payments come at a time when people’s real incomes (i.e. how much money they earn, adjusted for inflation) have plummeted. In the worst-case scenarios, people won’t be able to afford to pay monthly mortgage bills. In such a situation, banks would often repossess the house and sell it to recoup what’s owed. And since that puts more homes on the market, often at lower or “distressed” prices, that can lead to further downward pressure on house prices.

Mind you, housing markets vary a lot. And homeowners in some countries will be more affected by interest rate changes than others, depending on how exposed they are to rising rates.

Which countries are most exposed?

In the US, most buyers rely on fixed-rate home loans for as long as 30 years. Adjustable-rate mortgages represented, on average, only 7% of loans in the past five years. By contrast, home buyers in some other countries more commonly have loans fixed for as little as a year, or have variable-rate mortgages that move in line with interest rates. Australia, Spain, the UK, and Canada had the highest concentration of variable-rate mortgages as a share of new originations in 2020, according to Fitch Ratings.

Variable-rate mortgages as a percentage of 2020 new loans. Source: Fitch Ratings

Now the cracks in the global property market have already started to appear, and economists believe the worldwide downswing is only getting started. They’re most pessimistic about some of the frothiest markets like Australia and Canada, which, as we saw earlier, had some of the highest concentration of variable-rate mortgages as a share of new originations in 2020. Both countries are now seeing double-digit house-price declines. And it’s worse in Australia, where home prices in August recorded their largest monthly decline in almost 40 years.

Home prices are now falling sharply across cities that saw the biggest gains during the pandemic. Source: Bloomberg

How would this impact the global economy?

A globally synchronized housing market downturn would hit the global economy – which is already teetering on the edge of recession – in a few ways.

First, a sharp decline in house prices would significantly reduce wealth and lead to a drop in consumer spending.

Second, a stagnation or slump in property construction and sales would directly hit global growth, since these activities are huge multipliers of economic activity around the world.

Third, a declining property market would hit bank lending, as the risk of bad loans increases, choking the flow of credit that economies thrive on. What’s more, rising rates would add to pressures on property developers who borrowed heavily to finance their operations, leaving lenders increasingly concerned about developers’ ability to refinance their debt. Again, if this leads to bad loans, it would hit bank lending.

Fourth, as mortgage payments increase to reflect higher interest rates, people’s discretionary incomes will take a hit, which would further dent consumer spending.