Housing Market Crash Alert: What a Debt Default Would Mean for Mortgage Rates

Although lawmakers are appearing to make some progress towards a debt ceiling agreement, fears of a debt default-fueled housing market crash remain imminently relevant. Indeed, a default would be devastating for the still precarious real estate industry if the U.S. fails to raise the debt ceiling in time.

The U.S. has never defaulted on its debts before (at least not like this), so there’s plenty of speculation afoot about the actual repercussions of the event. But in short: It would be terrible for mortgage rates, the housing market, and just about everything else related to the economy.

The primary concern behind a default is that should the country breach its debt limit, credit rating agencies would likely immediately move to downgrade its credit rating. Mortgage rates, which tend to closely track Treasury yields, would increase as the security of government-issued debt is put into question.

According to real estate giant Zillow, 30-year fixed-rate mortgages could climb as high as 8.4% should the U.S. default, pushing up home buying costs by more than 22%. This would be a major black swan for housing demand and the U.S. economy as a whole. Housing accounts for almost a fifth of the total U.S. economy. Should real estate suffer a demand shock of such a degree, expect the entire economy to feel the repercussions.

“You’ll see a dramatic drop in buyers and when that happens, then you’re going to see property prices fall, a halt on different construction and home improvement projects,” Artin Babayan, a Los Angeles-based home loan officer told NPR.

Housing Market Crash Fears Run Hot Ahead of “X-Date”

With just days until the Treasury is estimated to run out of its so-called “extraordinary measures” funding, June 5 to be precise, mortgage rates are already starting to inch up. Indeed, 30-year fixed rates, which passed 5% for the first time since 2011 last year, topped 6.5% this week. This represents a notable increase from 6.39% from just the week before, seemingly due to the quickly approaching debt limit deadline.

“Although the probability of a default remains low, even the fears and panic related to a potential government default could cause creditors to ask for higher interest rates from the US Treasury, resulting in a significant increase in various borrowing costs, including mortgages,” said Jiayi Xu, a Realtor.com economist.

“Resolving the debt impasse sooner rather than later would mitigate potential adverse effects on the housing market, which is already contending with high prices and elevated mortgage rates.”

With interest rates already elevated from the Federal Reserve’s rate-hike campaign the past year and a half, investors are clearly anxious over any other upward forces on lending rates, especially mortgages.  Housing remains one of the single most rate-sensitive industries across the country. Given its already elevated state, even minor mortgage rate increases could yield significant blowback from would-be homebuyers.

Default Looms Large as Lawmakers Inch Towards Debt Ceiling Agreement

Perhaps the most troubling aspect of the current debt ceiling crisis is that even if the U.S. manages to avoid breaching the debt limit, there’s still a chance credit raters decide the downgrade the country’s credit. Indeed, some economists have surmised the fear and uncertainty that seems to hit the country every few years over lawmakers’ ability to negotiate debt ceiling-raising legislation. If you recall, in 2011, the U.S. had its credit downgraded even despite raising the debt ceiling before default.

That said, currently, things are looking up. According to Reuters, House Speaker Kevin McCarthy and President Joe Biden are apparently “closing in on a deal” to raise the debt ceiling for the next two years. This is a notable change of tone from just a week ago when the two paused meetings out of a lack of progress. Whether the country avoids default and/or a housing market crash remains to be seen.

On the date of publication, Shrey Dua did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

With degrees in economics and journalism, Shrey Dua leverages his ample experience in media and reporting to contribute well-informed articles covering everything from financial regulation and the electric vehicle industry to the housing market and monetary policy. Shrey’s articles have featured in the likes of Morning Brew, Real Clear Markets, the Downline Podcast, and more.

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