The U.S. government defaulting on its debt, which could become a reality as soon as June 1 without intervention, could send the typical cost of a mortgage soaring by 22%. Mortgage rates rising above 8% would likely overwhelm a small price dip to make affording a home an even steeper hill to climb and send home sales tumbling, according to a new Zillow analysis.
To be sure, the U.S. has never before defaulted on its debt, and it is very unlikely that the U.S. will fail to pay its debts now. This analysis projects what might happen in the unlikely worst-case scenario of a prolonged default, and it is not a prediction that a default will occur.
“Home buyers and sellers finally have been adjusting to mortgage rates over 6% this spring, but a debt default could potentially raise borrowing costs even higher and send the market into a deep freeze,” said Zillow senior economist Jeff Tucker in a news release. “Home values might not see a notable drop, but higher mortgage rates would severely impair affordability, for first-time buyers especially. It is critically important to find a solution and not put more strain on Americans who are striving to achieve their homeownership dreams.”
A debt default would almost certainly mean severe disruption for the economy, with the ripple effects taking their toll on the housing market. One highly likely consequence would be rising interest rates — including mortgage rates — as shaken confidence in Treasury bills being repaid means investors would require a greater return before purchasing them. Mortgage rates tend to follow Treasury rates and would be expected to rise as a result.
Home shoppers already are finding few options they can afford this spring, and it’s estimated that a mortgage would cost 22% more in September in the event of a debt default than it otherwise would. That’s on top of an 82% rise over the past two years.
A steep rise in mortgage rates — projected to peak at 8.4% in September in this scenario — would freeze sales in an already chilled market. If the affordability mountain grows even taller, fewer would-be buyers will be able to purchase a home. Higher mortgage rates also discourage homeowners, many of whom locked in their loans when mortgage rates were near 3%, from selling and reentering the market when their new loan would be much more costly.
Zillow projects this combined impact of buyers and sellers pulling back would wipe nearly one-quarter of expected sales off the board in some months. If there were to be a debt default, the biggest projected deficit would come in September, with an estimated 23% fewer existing home sales.
The thin silver lining for the overall health of the housing market is that Zillow economists don’t expect home values would lose much ground, even with a default. Home values have turned the corner this spring, returning to growth near historical norms after a period of overheating and then a short-lived downturn. Home values tend to fall sharply when there is a glut of listings flooding the market, but very low inventory in this scenario would act as a parachute, keeping prices from falling too far, too fast.
Zillow forecasts that if the U.S. were to default on its debt, home values would begin to fall starting in August, but only by 1% from current levels through February 2024. Even in this pessimistic scenario, home values are expected to rise 1% from today to the end of next year. That’s down from a current expectation of 6.5% growth over that period.