High Mortgage Rates Stir Up Demfor Smaller Homes | Mortgages Advice

Mortgage rates climbed higher this week, once again passing the 7% threshold for the 30-year fixed mortgage term. Fixed mortgage interest rates increased across the board this week, while most adjustable mortgage rates declined slightly.

Here are the current mortgage rates, without discount points unless otherwise noted, as of May 18:

“Mortgage rates have remained in the roughly 6% to 7% range for the last eight months will likely remain in this range until incoming economic data makes the economy’s path forward more clear.”

– Realtor.com data analyst Hannah Jones, in a May 18 statement

The Federal Reserve’s sustained monetary policy tightening has kept mortgage borrowing costs elevated since officials first began raising the federal funds rate in early 2022. Since then, inflation has come down from its peak, although it still remains well above the Fed’s target rate of 2% annually. On the other hand, the job market has remained stubbornly strong, with the unemployment rate still near historic lows.

“Recent data shows signs of a stubborn, though slowing economy, suggesting that the Fed’s contractionary actions are having the intended effect,” Jones says.

Inflation is expected to continue falling in the coming months, especially as lenders begin to tighten their balance sheets implement stricter credit requirements in the wake of turmoil in the banking industry.

But until the Fed starts seeing some tangible progress on inflation, policymakers won’t implement any rate cuts, which will keep mortgage rates elevated. In the meantime, all eyes are focused on incoming economic data on consumer prices the job market.

In a welcome return to sanity – but more so in an effort to combat affordability challenges – homebuilders are beginning to shy away from constructing excessively large homes. The median square footage for a new home construction started in the first quarter of 2023 was 2,261, down significantly from the peak size of more than 2,500 square feet in 2015, per U.S. Census Bureau data dating to 1999.

This downsizing trend comes as more homebuyers are turning to new construction homes while current homeowners remain reluctant to sell risk losing a record-low mortgage rate. In March, a third (33%) of homes listed for sale were new construction homes – up from the 12.7% average between 2000 2019, according to the National Association of Home Builders.

“Whenever you see an increase in interest rates a decline in housing affordability, the market shifts a little bit toward somewhat smaller homes,” NAHB Chief Economist Robert Dietz tells Realtor.com.

Still, starter home construction remains far below the necessary level to keep up with demand. Freddie Mac defines a starter home as one that’s 1,400 square feet in size or less. Just 3% of new construction homes sold in 2021 fell into that category, down from 11% in 2003, according to the Census Bureau. Meanwhile, a third of new builds sold in 2021 were between 1,800 2,399 square feet, about a quarter (23%) were 2,400 to 2,999 square feet.

What’s more, only 24% of newly constructed single-family homes sold in 2021 were priced under $300,000. In 2002, the vast majority (79%) of new construction homes sold for that amount.

It’s no secret that new construction homes have ballooned in size (price) over the last several decades. After all, America is the home of the McMansion – which is just slang for an unnecessarily large yet cheaply constructed house. In fact, Merriam-Webster sums it up pretty well: “a very large house built in usually a suburban neighborhood or development,” especially “one regarded critically as oversized ostentatious.”

Now that homebuilders seem to be embracing the need for more modestly sized homes, it raises the question: Will a reduction in square footage actually translate to a lower home price? Or is it just a way for homebuilders to cut costs while consumer demkeeps prices high?