The Global Housing Crisis Colliding With Rising Interest Rates

When nothing is moving in a neighborhood, a certain kind of silence descends. There are no sold signs. No trucks for removal. There are no young couples debating whether the backyard is large enough while standing in driveways. Every city, from Toronto to Berlin to Auckland, has grown accustomed to that silence. It’s the sound of a housing market that has effectively shut down, with millions of regular people waiting outside to see if the door will ever open again.

The global housing crisis and sharply rising interest rates did not suddenly collide, but they did so more quickly than most anticipated and more forcefully than nearly anyone had predicted. In order to combat the worst inflation in forty years, central banks all over the world started raising interest rates in 2022. Many housing economists surreptitiously predicted that a correction was imminent.

During the pandemic, home prices had skyrocketed in ways that defied logic, or at least defied the logic that prevailed during earlier recessions, when housing markets usually softened as economies contracted. Housing prices in some cities increased by twenty or thirty percent in a single year as a result of the influx of locked-down households with stimulus money and newfound freedom to work remotely.

Perhaps the most striking example is New Zealand. Property values increased by about 30% in 2021. First-timers made up a fifth of the buyers that year, and many of them were straining to pay for what they hoped would be a long-term residence. The fact that New Zealand mortgage contracts fix for three years or less, leaving borrowers vulnerable when rates reset, was something they were unable to fully account for. Between late 2021 and 2023, the Reserve Bank increased interest rates by more than five percentage points.

By mid-2024, it is anticipated that the percentage of household disposable income allocated to mortgage repayments will have more than doubled from its lowest point to approximately 20%. What appeared to be a wise purchase now feels like a financial trap to many of those first-time buyers. Some have managed, but only slightly, thanks to strong wage growth.

The dynamic is different but just as oppressive in the US. In early 2021, the 30-year fixed mortgage, which has long been regarded as the cornerstone of American homeownership, had a rate of about 2.65 percent. It increased to about 7.4 percent by the end of 2023.

As a result, the market is now referred to by experts as “glacial,” a term with significant implications. It’s not merely sluggish. At depth, it is frozen. There is no logical reason for homeowners who locked in at historic lows to sell and take out a new mortgage at three times the interest rate. Thus, they don’t.

Additionally, inventory does not move because they do not. Additionally, despite the pressure on buyers, prices persistently remain high due to the thin inventory. The US housing market is the least affordable it has been in forty years, with an average home now costing about 40% of average household income, according to data from ICE, the Intercontinental Exchange, confirming what many buyers already suspected.

This is where the “lock-in effect” described by economist John Quigley, which was first noted when mortgage rates doubled from nine to eighteen percent in the late 1970s and early 1980s, has resurfaced with fresh significance. The idea is straightforward: when borrowing costs skyrocket, homeowners who already have inexpensive mortgages just stay put, which lowers supply and keeps prices high, pricing out potential buyers.

Quigley recognized this decades ago, and the idea was discreetly forgotten as rates declined during the 1990s and 2000s. It was taken off the shelf by the pandemic.

While this is going on, Europe is facing a different but related issue. The coalition government in Germany promised to construct 400,000 new homes annually. It’s not even close. In just the first half of 2023, building permits decreased by 27%. Construction activity collapsed similarly in France. In the first ten months of 2023, over 1,100 construction companies in Sweden filed for bankruptcy, a 32 percent increase from the previous year.

Governments still plagued by their post-pandemic deficits are hesitant to intervene with public spending, and higher rates have rendered new development financially unfeasible. As a result, there are supply and affordability crises that exacerbate one another.

The extent of the decline is demonstrated by a new cross-national dataset created by International Monetary Fund researchers. By 2024, the affordability index in the United States had fallen to the mid-80s, below the qualifying threshold, from roughly 150 in 2021, indicating that the average household earned significantly more than required to qualify for a standard mortgage.

During the same time period, the index in the UK dropped from 105 to the low 70s. Housing affordability is generally worse now than it was during the home price bubble that preceded the global financial crisis of 2007–2008 in all of the countries examined. It is not a statistic that should be skimmed over.

When lower interest rates occur, they might provide some respite. But maybe not as much as people would like. According to research, only roughly 25% of changes in affordability have historically been attributed to rate changes. Furthermore, there is a legitimate fear that declining interest rates will only attract more buyers, driving prices back up.

Restrictive zoning regulations, land scarcity, overburdened planning systems, and underfunded public housing are examples of structural issues that existed prior to the pandemic and will continue to do so. Chile’s experience is instructive: according to modeling, a 100 basis point increase in mortgage rates results in an 18 percent decline in home sales in just one quarter, which builds to a cumulative decline of 57 percent by year’s end. There isn’t a ripple there. It’s a wave.

There’s a feeling that this crisis is changing more than just real estate markets, as evidenced by postponed marriages, adult children sharing childhood bedrooms, and the silent resignation of those who have given up looking. Expectations are changing as a result.

The generation that is currently in their late twenties and early thirties was raised by parents who purchased homes, accumulated equity, and used the property as a place to live as well as a retirement strategy. They do not have the same access to that model, and economists are just starting to quantify the psychological impact of that.

The road back to widespread housing affordability is a long and genuinely uncertain one, whether through supply reform, targeted subsidies, or a gradual unwinding of monetary policy. The scope of the issue is certain. The cost-bearing individuals are not abstract concepts in a dataset, the numbers are substantial, and the trends are unyielding. They are currently outside, observing the quiet neighborhoods and speculating about what might happen next.