The housing market is one area of the economy that has been impacted by the Federal Reserve’s recent monetary policy moves, which started March of last year. These policies were put in place in an attempt to slow down inflation. Instead of keeping near-zero interest rates on its target federal funds rate, they raised them rapidly. And by February of this year, the rate was set to a range of 4.5-4.75%. 

While these higher interest rates were meant to slow down inflation, few areas of the U. S. economy felt the impact of this policy as quickly as the housing market. As interest rates continue to go up and the threat of a recession becomes more real, the demand for housing has slowed down.

Current mortgage rates

The national average for mortgage interest rates for a 30-year traditional mortgage is over 6.5% as of February 2023. This is more than double the national average mortgage interest rate from the beginning of 2022, which was 3.22%. In Spring of 2022, the Federal Reserve started making a series of interest rate hikes, which made it less affordable to borrow money. Now, mortgages are actually higher than the federal funds rate!

This is only a rough guide, because the buyer’s interest rate will depend on certain factors. Some of them can include the following:

• Down payment.
• Credit score.
• Debt-to-income ratio.
• Location.

Even if you have a solid borrowing profile, you will still have to pay a higher interest rate compared to what you would have to pay in the early part of 2022. A homebuyer with a 20% down payment for $550,000 home and a 6.44% interest rate on a 30-year fixed mortgage will have to make a monthly payment of $2,764. At the beginning of 2022, that same loan would have a rate of 3.22% and monthly payment of $1,908. This is a difference of $874.

A decline in mortgage applications

Rising interest rates have put a great deal of downward pressure on mortgage applications. The average mortgage contract interest rate has decreased during the last two months – from 7.08% to 4.42% by the year’s end. This caused a slight increase in mortgage applications because buyers wanted to lock in a lower rate, but it was short-lived. Applications dropped significantly in the last two weeks of the year. 

While interest rates were also down for refinances over the same period, the number of applications didn’t go up. This was most likely because most homeowners refinanced in the early part of 2022 when rates were much lower. For new homebuyers, it’s a common belief that refinancing is only worth it if the interest rate on a new loan is at least 1% lower than what they have on their current loan.  And because rates haven’t dropped by 1% from their highs, less people were looking to refinance.

In 2023, mortgage rates have started to go back up. So, when mortgage application data is released, it will most likely show a decline in volume. Many experts believe this slowdown is because winter is usually the slowest time for home sales, and they believe that mortgage applications will go up when the weather gets warmer (which is when people usually put their homes up for sale). However, the increase is expected to be minimal because of rising interest rates (which will make homes less affordable for average buyers).

Housing prices are still strong

Despite the rising interest rates, housing prices are staying high. Part of this is caused by tight inventory, but it’s also because sellers want to get as much as they can for their homes and aren’t open to as much negotiation. Under normal circumstances, the price of a home is set at a maximum value. And buyers often negotiate a lower price.

The rush for homes during the pandemic caused housing prices to spike, and buyers were making offers that were well above the asking price. This caused sellers to get their homes sold in a couple of days – all while getting a good amount for the sale and enjoying the financial benefits that came with it. But rising interest rates have made it harder for buyers to afford the monthly payment. This has been compounded by employment uncertainty, which makes it much more difficult for buyers to justify the extra cost. Sellers who don’t want to give up their profit by keeping home prices high and not being willing to negotiate for a lower price have caused homes to stay on the market for a lot longer than they have been in the past.

The housing market looking forward

Housing prices usually drop during a recession. And while some areas of the country will see them go down, a substantial price decline on a national level doesn’t appear to be likely. This is caused by a lack of supply and increasing inflation, which is adding to the cost of newly-constructed homes. Any inventory increase is most likely the result of homes staying on the market for longer than usual than new homes being listed. A lot of homebuilders have slashed their production, because of a weaker housing market and higher costs.

Most experts believe that a drop similar to what we saw in 2008 isn’t likely (even after the Federal Reserve is planning to keep the federal funds rate high until inflation shows signs of easing). The best-case scenario for the housing market is that inflation will start to cool off by the summer, and the Federal Reserve will lower rates (or at least stop raising them). Mortgage rates will drop during the second half of the year (which will spur the housing market).

For the worst-case scenario, inflation will stick around. And the Federal Reserve will have to raise rates again (possibly in the 5%-6% range). Housing demand will continue to decline as interest rates get close to double digits, which will make homes less affordable for most prospective buyers. But most experts believe that the housing market will start to recover in 2024 as inflation slows down and the economy improves. This will give consumers the confidence they need to buy a home.

The bottom line on how high interest rates will affect the housing market

Housing demand is slowing down because of higher interest rates and the fear of a recession. While most experts don’t think the housing market will crash, the slowdown in sales will cause home prices to go up more slowly. If you’re interested in buying a home, it’s a good idea to keep an eye on current mortgage rates and other economic indicators (including the Federal Reserve) to see if they will go any higher. If there’s a good chance they will go up, locking a rate in sooner than later may be a smart move.

If you want to know more about how you can make money with real estate, be sure to get in touch with Trevor Shakiba at Shakiba Capital.