Great ResignationClimate ChangeLeadershipInflationUkraine Invasion

High mortgage rates are here to stay. Here’s why that’s bad news for county governments–and their taxpayers

November 4, 2022, 4:58 PM UTC
An aerial view of completed and under construction new homes at a site in Trappe, Maryland, on Oct. 28. New home sales in the U.S. dipped in September, as worsening affordability nudges ownership further out of reach for many.
JIM WATSON - AFP - Getty Images

In recent years, many local municipalities and state governments have built up record budget stabilization funds–also known as rainy-day funding–so they can pay for additional services, unexpected costs, emergencies, overruns, future pandemics, and infrastructure.

These rainy-day funds were flush with cash thanks to surplus funding related to the pandemic, record homebuying, and very low interest rates. In 2021, all 50 states averaged rainy-day funding at roughly $34 million dollars. Wyoming led the way with $300 million and Washington State was at the other end of the spectrum with a deficit of $2 million, according to Pew Research.

The surplus money has led to both increased government service spending and tax cuts–but there is real trouble ahead. One of the revenue streams that has boosted the coffers of localities and state governments is facing a coming drought: the loss in fees and supplemental taxes that are generated from refinancing and homebuying opportunities. Record-high homebuying and refinancing over the last five years has generated a nice financial egg for most governments. That will no longer be the case.

With high interest rates impacting the nation, recent data shows that both home sales and refinances are way down. Home sales were down 5.4% from May 2022 and almost 15% in 2021, according to data published by the National Association of Realtors (NAR). By some estimates, housing prices could dip by as much as 20% in more than 180 markets nationwide if the U.S. economy falls deeper into a recession. Experts at the research firm Moody’s Analytics have said that homes in 183 of the 413 largest regional housing markets in the country are “overvalued” by more than 25% and 183 housing markets could soon see home prices fall by as much as 20%. With this expected downturn, many governments’ bottom lines will be hit.

The drop in revenue isn’t an isolated problem. These unfortunate results are directly related to high inflation. The Federal Reserve has been raising interest rates in hopes of slowing down the pace of inflation. However, these rates are not expected to drop anytime soon, as inflation proves stickier than previously forecast, and key areas of the economy, like the labor market, won’t cool fast enough.

According to a CNBC survey of economists and investment managers, the Federal Reserve is likely to hold rates there throughout 2023 and perhaps additional rate increases. This outlook implies at least two more rate hikes in November and December, for a total of at least 75 basis points more,

These rates have a direct result on prospective homebuyer decision-making. It also affects Americans seeking to refinance their home since the available interest rates are so undesirable.

The mortgage rate for borrowers with excellent credit is hovering now over 7%–the highest since 2008. These unusually high interest rates have essentially wiped out the mortgage refinance business boom that blossomed from 2015-2020. The high rates have also dissuaded many first-time home buyers from moving on from renting to finally purchasing a home of their own. Americans haven’t seen mortgage rates this high in more than 50 years (since 1971 to be exact), according to the online service, Mortgage Reports. There is no indication those rates will be dropping any time soon. In fact, they’re expected to rise.

Today, the average recording fee and transfer tax for a homebuyer or refinance brings in almost to $100 to $200 per transaction. In 2010, the United States saw over 3.1 million refinances.  Locally, county governments realized this increase. For example, the largest country in Arizona, Maricopa County, there were 78,101 refinances, which brought in nearly $15 million dollars in revenue.

Naturally, these interest rate hikes are on top of an already volatile bond market. Bonds are being hammered all over the world. In the U.S., bond investors are experiencing large paper losses that are closely connected to red-hot inflation and to the rising interest rates engineered by the Federal Reserve to curb soaring prices. Because bond prices and interest rates (a.k.a. yields) move in opposite directions, the steep rise in rates has automatically led to deep drops in bond prices.

With the record low of homebuyers caused by high interest rates, inflation, and a sporadic bond market, local governments will need to look elsewhere to supplement this revenue loss and maintain even smaller rainy-day funds. Sadly, this could result in either higher taxes or a loss of substantial assistance to the residents they serve.         

T. Michael Andrews is SVP at McGuireWoods Consulting in Washington, DC focusing on housing and Native American issues.  

The opinions expressed in Fortune.com commentary pieces are solely the views of their authors and do not necessarily reflect the opinions and beliefs of Fortune.

More must-read commentary published by Fortune:

Sign up for the Fortune Features email list so you don’t miss our biggest features, exclusive interviews, and investigations.