While the Federal Reserve’s inflationary policies are publicized as protecting the American people, they are causing the American dream of homeownership to slip away. By raising the federal funds rate to combat their self-inflicted inflation, the Fed has driven up mortgage costs, making it harder for aspiring homeowners to secure a place in the housing market. These policies have resigned aspiring homeowners to a future of perpetual renting.
At the beginning of 2022, the federal funds rate was 0.08%. As of June 2024, that number is 5.33%. The rate hike was in response to the rampant inflation of previous years. The Consumer Price Index (CPI) rose 7.0% in 2021 and 6.5% in 2022, far exceeding the Fed’s 2% target. This spike was caused by the trillion-dollar infrastructure bills, COVID stimulus packages, and other imprudent government expenditures that had motivated the FED to increase the money supply. This inflation erodes purchasing power, increasing the cost of living for millions of Americans. With the economy in this desperate state, the FED attempted to counteract it with a federal funds rate surge. While increasing this rate is a proven tool to combat inflation, it is not without cost to consumers.
The federal funds rate is the interest rate banks lend each other overnight. It effectively sets the interest rate floor for the economy. When the FED increases this rate, it creates a chain reaction that increases borrowing costs for everyone, including those seeking mortgages. In response to the federal funds rate hike, the 2021 mortgage rate of 2.65% skyrocketed to 7.74% in June 2024.
This surge is devastating for potential homebuyers. Higher mortgage rates reduce what potential homeowners can afford. More of their monthly payment goes towards interest rather than principal, drastically affecting their buying power. For every 1% increase in mortgage rates, a buyer’s purchasing power decreases by approximately 13.80%. This means that a potential buyer who could previously afford a $750,000 home may now only qualify for a $646,500 home, assuming a fixed amount for a down payment.
This pushes previously affordable homes out of reach for many buyers and slows the housing market. According to the National Association of Realtors, the Housing Affordability Index dropped from 148.2 in 2021 to 98.2 in 2023, indicating a significant decrease in the ability of a median-income family to afford a median-priced home. This decline in affordability has led to a slowdown in home sales, with existing home sales falling from 6.12 million in 2021 to 4.09 million in 2023.
For borrowers with adjustable-rate mortgages (ARMs), the impact of federal funds rate hikes is even more direct. The federal funds rate influences the financial indices to which ARMs are tied. As the rate increases, so does the index, leading to higher monthly payments for ARM holders. This process creates financial strain for borrowers who didn’t anticipate such increases when they initially took out their loans.
Federal funds rate hikes have also had broader economic implications. The housing market is a crucial driver of economic activity, influencing everything from construction and real estate services to consumer spending on household goods. Housing-related activities typically account for 15-18% of GDP and the recent downturn has affected various sectors. For instance, new housing starts declined from 1.61 million in 2021 to 1.41 million in 2023, reflecting the cooling effect of higher rates on construction activity. When mortgage rates climb and home buying slows, these sectors experience a downturn, rippling throughout the economy.
Raising the federal funds rate is one of the FED’s classic inflation reduction methods. However, the root of the problem is the source of the inflation. Wasteful government spending and expansionary monetary policy were the origin of the crisis. The current regime believes frivolous expenditures and printing money won’t lead to negative consequences. But for the millions of Americans struggling to buy a home, or crushed by the crippling cost of living, these policies are far from benign. For rich politicians whose financial futures are set, the gravity of the situation may not be evident. But for homeless, hungry Americans, the time for action is now.
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