In March 2022, the Federal Reserve began tightening monetary policy to combat surging inflation. The effects have been felt throughout the economy, and the housing market is no exception.
According to Home Mortgage Disclosure Act (HMDA) data, the median interest rate for purchase mortgages increased from a historic low of 3.00 percent in 2021 to 4.88 percent in 2022. The rate increases in 2022 coincided with a significant decline in mortgage originations (19 percent) after two consecutive years of record-high mortgage originations.
Median Interest Rates Rose and Total Purchase Mortgage Originations Declined in 2022
|Median interest rate (%)
|Total purchase originations
|Percentage change in purchase originations
Source: 2019–22 Home Mortgage Disclosure Act data.
Notes: Results are shown for the purchase of owner-occupied, single-family homes.
Our analysis shows that those with lower incomes and lower down payments experienced a greater decline in purchase mortgage originations, indicating that the increase in mortgage interest rates has had a disproportionate impact on those with fewer financial resources. Borrowers earning less than 80 percent of the area median income, for example, experienced a 22 percent decline in mortgage originations between 2021 and 2022. With mortgage rates now up to about 7 percent, buyers with fewer financial resources will continue to face greater barriers to homeownership.
Rising interest rates have affected the supply and demand for homes
Interest rates have curbed both supply and demand for homes, which has influenced the decline in originations. When mortgage rates go up, monthly housing payments on new purchases also increase. For potential buyers, increased monthly payments can reduce the share of available affordable homes, pricing them out of the market. Additionally, higher interest rates mean fewer homes on the market, as existing homeowners have an incentive to hold on to their home to keep their low interest rate.
High rates also affect mortgage credit. As rates go up, so does a borrower’s debt-to-income (DTI) ratio. Loan programs have DTI thresholds that determine eligibility. If a borrower’s DTI ratio surpasses 50 percent, it is difficult to obtain a conventional mortgage, and if a borrower’s DTI ratio is above 57 percent, the borrower is ineligible for Federal Housing Administration loans. Many borrowers who would have been under the DTI threshold in 2021 were pushed above it because of the rate spike (PDF).
This effect on borrower eligibility can also be seen in mortgage denial rates, which increased 2 percentage points to 14 percent for all purchase borrowers in 2022. DTI ratio was indicated as the leading reason for denial. It was the reason on 34 percent of denied loans in 2022, up from 30 percent in 2021.
The interest rate increase hasn’t affected individuals and households equally
Breaking out the decline in purchase mortgages by different credit and borrower characteristics can show which potential buyers were disproportionately sidelined. Overall, the shares of low-income and high-combined-loan-to-value (CLTV) borrowers each declined by about 22 percent.
The number of mortgages originated to white borrowers dropped by the highest share, which is likely explained by white households being more likely to have an existing mortgage with an interest rate near 3 percent, meaning they would have less incentive to move.
For white borrowers with low incomes, the decline in originations was similar to the overall decrease, but for borrowers of color, the decline was more pronounced. Lending to borrowers with low incomes fell 4.5 percentage points more than overall lending for Black borrowers, 5.7 percentage points more for Hispanic borrowers, and 8.7 percentage points more for Asian borrowers. This comparison suggests that borrowers of color with low incomes could be more sensitive to rate changes because they don’t have the wealth to put together a larger down payment to mitigate the effects of rate increases.
The share of originations with high CLTV ratios fell the most for white borrowers. Although more research is needed, it is possible that a greater share of white borrowers—who, on average, have more wealth—were able to move to a lower CLTV category with a larger down payment, while many Black and Hispanic households dropped out of the homebuying market.
Lastly, the share of cash buyers and the share of investors increased in the market between 2021 and 2022. According to data from Realtor.com, the share of cash buyers increased from 32.4 percent to 36.1 percent during this period. The investor share, provided by CoreLogic, increased from 32.1 percent to 40.1 percent. These changes suggest that the rate increase strengthened the relative purchasing power of those with greater capital, as they can put down a larger down payment or pay fully in cash.
Several policies and programs can improve access to homeownership in a high-rate environment
Rising interest rates have suppressed the number of mortgages being originated through worsened affordability, but the effect is more acute for loans with characteristics on the margins of eligibility. Borrowers who have less money to put down and lower incomes also tend to represent the lower end of homeownership in the US.
Rate buydowns, which let borrowers secure lower interest rates by paying for “points” up front, could offer one solution to maintain accessible homeownership during high-rate periods. Buydowns can reduce DTI ratios and increase the long-term affordability of mortgage debt. Programs that offer rate buydowns through grants or forgivable loans may help borrowers that wouldn’t be able to afford homes on their own.
For borrowers who cannot afford buydowns, expanding providers of down payment assistance programs, including special purpose credit programs (SPCPs), may help. SPCPs are run by individual lenders to help historically disadvantaged groups access credit. Most SPCPs currently provide down payment and closing cost assistance, which can also help lower the DTI ratio and up-front costs of homebuying.
Without these policies or others that can lower barriers for borrowers with fewer resources, the disproportionate decline of homebuying in high-rate environments could exacerbate existing homeownership and wealth gaps.