Rising mortgage interest rates are hitting the brakes on a red-hot U.S. housing market, but in the long run, it may bring a whole new world of hurt for homebuyers. 

The average rate for a 30-year mortgage loan jumped to 5.22 percent this week, according to Freddie Mac. That's up from around 2.8 percent this time last year, and the higher rate is already translating into reduced demand and signs that homebuilders are pulling back: Construction spending fell 1.1 percent in June from the month before, while housing starts fell 2 percent, and housing completions dropped 4.6 percent, according to the U.S. Census Bureau. 

On the one hand, this is exactly what the Fed intended. With home prices hitting all-time highs since the COVID-19 pandemic started, more expensive mortgages should in theory turn buyers away and eventually bring down prices. The problem is that, in addition to reducing prices, the fall-off in demand is also sending a signal to developers that they shouldn't build.  Against the backdrop of a nationwide housing shortage, this could pave the way for higher prices to come roaring back. 

"Obviously, when you double rates in four months, demand is going to slow," said Whit Marshall, owner of Paran Homes, a residential construction firm based outside of Atlanta, "But the real issue is this huge shortage of inventory, and all this is doing is making things worse, which is why I don't think prices going to come down."

While builders recognize that there is a shortage of inventory, the drop in demand is leading many to hedge their bets until the smoke clears around the Fed rate hikes. 

"Builders build homes in response to demand," said Ali Wolf, chief economist for Zonda, a home construction data company. "Demand for housing has slowed notably in 2022 as higher home prices and interest rates have pushed the cost of homeownership up roughly 50 percent compared to the beginning of the year."

She added that a Zonda survey of builders found that 87 percent planned to slow housing starts in response to the changing market, even as others continue to invest in longer-term projects. 

"What we are finding is that the development community is thinking through the short-term shifts, but many players are still investing money in land where they know the homes will come to market over a longer timeframe — say one to three years," Wolf said. 

Some argue that the U.S. can't afford to wait around for the construction industry to get back into gear. A recent report from Up for Growth, a cross-sector advocacy group focused on addressing what it calls "housing underproduction" in the U.S., found that the country is 3.8 million homes short of meeting housing needs — a problem that it said is being complicated by the fact that housing supplies vary greatly between different cities and regions. 

"As people migrate in search of jobs, education, and economic opportunities, the demand for housing in our most economically productive regions far exceeds the production of new homes," said the report. 

In many ways, this situation is the legacy of the last housing crisis. After the housing bubble popped in 2007, construction fell off precipitously, leading to a kind of lost decade for the sector. There were 6.8 million housing starts in the 2010s, according to the National Association of Home Builders, compared to nearly double that during the housing boom of the 2000s. The downturn had the added effect of reducing the number of builders and laborers in the industry, which left developers ill-prepared to ramp back up when demand recovered. 

"A lot of this is the aftermath of 2007, honestly," said Marshall. "When the whole market collapsed, so did all the banks, so did all the developers, so did all the builders." 

Meanwhile, a demographic shift was about to make the problem even worse. As millennials aged into prime homebuying years — much to the surprise of many a think-piece writer who noted the generation's penchant for renting rather than buying — housing demand skyrocketed, and U.S. supply simply wasn't ready for it.  So begins the age of bidding wars. 

Now the housing market is getting knocked down once again, and it's unclear how quickly it will recover and whether or not it will be up to the task of addressing the shortage once it does.  

In the meantime, despite a doubling in mortgage rates, housing prices remain high. The latest consumer price index showed the cost of shelter rising 0.4 percent in July, and the National Association of Home Builders reported Thursday that housing affordability has fallen to its lowest levels since the Great Recession, 

“Rising housing costs stemming from increased interest rates, supply chain disruptions that have led to higher prices for building materials, and a persistent lack of construction workers are dramatically affecting home prices,” said NAHB Chairman Jerry Konter, a developer from Savannah, Georgia, in a press release. “Taming housing costs will ultimately require building more homes, and it will be easier to increase production in more affordable smaller and mid-sized markets that are growing in population and attracting new businesses."

Paul Williams, founder of the Center for Public Enterprise, a think tank focused on coming up with solutions for pressing social problems such as housing, said the problem shouldn't be left to private builders alone. Government should also play a role. 

He pointed to the example of the public housing authority in Montgomery County, Maryland, which is building mixed-income public housing in an attempt to bolster supply in the area despite a lack of interest in such projects from developers and financial institutions. 

"Public agencies should be countercyclical programs that can produce housing via the public sector even when the market isn't interested in producing housing," he said.