Debt Ceiling Showdown: The Potential Impact on the U.S. Housing Market

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The U.S. government’s fiscal health is under scrutiny as lawmakers continue to debate the debt ceiling. Democrats advocate raising the ceiling unconditionally, while Republicans insist on accompanying it with spending cuts. Failure to reach a consensus could lead to an economic "calamity", as described by the U.S. Treasury Secretary.

In this context, one might ask, how would this so-called "calamity" affect the U.S. housing market? A recent report from Zillow explores this very question.

Although the report acknowledges that a U.S. default is generally considered "unlikely", it nonetheless presents a sobering forecast in the event of such a scenario. If the U.S. defaults on its debts, which could happen as early as June, mortgage rates could potentially exceed 8% by September. This would result in a significant increase in mortgage payments for new borrowers, over 20% higher than current rates.

This hypothetical scenario could not arise at a more inopportune time. Mortgage rates jumped from 3% to 6% last year, mirroring a concurrent surge in home prices which rose by an astonishing 41% during the Pandemic Housing Boom. These combined factors have considerably eroded housing affordability, pushing it to levels reminiscent of the housing bubble era. An escalation of mortgage rates to over 8% could thrust the housing market back into a so-called "deep freeze".

To put things into perspective, let's consider the difference in monthly mortgage payments for a $600,000 home at 6% and 8% interest rates. Assuming a 20% down payment, a 6% mortgage would amount to approximately $2,878 per month (excluding taxes and insurance). However, under the same conditions but with an 8% mortgage rate, the monthly payment would escalate to $3,522, representing a substantial $644 monthly increase. This spike in costs would likely exclude many potential buyers from the market and further alienate those who have been waiting on the sidelines since last year's rate increase.

The report goes on to forecast the potential evolution of the housing market over the next 18 months, in the event of a debt default. It estimates that existing home sales could plummet by as much as 23% compared to the baseline no-default forecast, while home values might end up 5% lower at the end of 2024 than anticipated in a no-default scenario.

Translating this into absolute figures, if mortgage rates were to exceed 8%, the current figure of 4.3 million existing home sales (as of April) could plunge to 3.3 million by September, marking a drastic 23% reduction. Contrast this against the volumes seen in 2021 and 2022 and they annual declines in transaction volumes are reduced by nearly 50%.

The report concludes by warning that any major disruption to the economy and debt markets would have profound repercussions for the housing market. Higher borrowing costs and suppressed sales could stifle the market just as it begins to stabilize and recover from the significant downturn of late 2022. This potential scenario underscores the crucial role of fiscal responsibility and effective policymaking in ensuring the health and stability of the housing market. As negotiations around the debt ceiling continue, all eyes will be on Capitol Hill, waiting to see the impact of their decisions on the future of American homeownership.

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