By KIMBERLEY HAAS
With the average mortgage rate hitting over 7% for the first time in 20 years, people are talking about what the 2023 housing market will look like.
A year ago at this time, the 30-year FRM averaged 3.14%, and in 2021, existing-home sales hit 6.12 million, their highest level since 2006.
Zillow’s Home Value and Sales Forecast now calls for 5.2 million existing home sales in 2022, up slightly from September’s expectations for 5.1 million sales following a better-than-expected August.
The outlook from there is cloudier and recent declines in mortgage applications and pending home sales activity suggest that there are significant downside risks to home sales volume into 2023, according to the forecast.
Orphe Divounguy, Senior Economist at Zillow, answered some questions about mortgage rates for The Mortgage Note last week.
How did mortgage rates contribute to the surge in demand over the course of the pandemic?
Mortgage rates were trending down heading into the pandemic, hit all-time lows near 2.5% in January 2021, and stayed below 4% into March of 2022. This represented an opportunity for the leverage of a lifetime for anyone even remotely considering buying real estate, from first-time buyers to those securing second and vacation homes.
The run-up in house prices during the pandemic was due to a combination of both demand and supply factors.
On the demand side, demographic trends played a key role. As a large number of U.S. residents entered home-buying age, demand for housing increased.
The pandemic shock and the rise of work-from-home also meant many families required more space. In addition, fiscal stimulus raised household income and savings to support demand.
Lastly, falling real interest rates helped to support asset valuations. Both stock market and housing market wealth increased. The user cost of housing declined through savings on financing costs.
On the supply side, the U.S. construction sector was caught flat-footed. The nation entered the pandemic with a pre-existing housing unit deficit. The pre-existing housing deficit combined with a breakdown of supply chains resulted in the buildup of available housing severely lagging the pandemic surge in demand.
The massive increase in demand and competition emptied out local housing inventories and prices skyrocketed, breaking annual growth records for months on end. The Fed’s delayed response to surging inflation dragged down real interest rates further.
Homeowners who didn’t buy a new house likely refinanced their existing one, or did both, using a cash-out refi to finance their next purchase.
How are they affecting the market now?
Mortgage rates have seen the fastest hikes in recent history this year, pushing housing affordability near an all-time low. There has been upward pressure on rates throughout 2022 for a number of reasons. Inflationary pressures are the main culprit.
First, higher inflation benefits borrowers at the expense of lenders. As inflation increases, the likelihood of not achieving the inflation target for individual assets increases. As a result, the required rate of return for new investments must increase.
Secondly, as the Fed raises interest rates and tightens monetary policy, the return on less risky assets goes up, pushing up the premium lenders require for taking on additional risk that comes with mortgage lending, for example.
Buyers are being pushed to the sidelines as both down payments and monthly mortgage costs grow beyond their budgets.
Potential sellers who tend to buy again after selling have little incentive to give up a low rate for today’s much higher rate. New listings were down 16% in September when compared to a year ago. As a result, housing sales have slowed dramatically.
Home values are also ticking down slowly across many U.S. markets, and more significantly in areas with the most expensive houses and in places that saw the highest appreciation during the pandemic.
This was part of the Fed’s plan to cool an overheated U.S. economy. A feverish housing market is undergoing a much-needed market rebalancing to more sane market conditions after the demand-fueled rush for real estate we saw over the past two-plus years.
Despite this affordability crunch, there is some hope for buyers who are still in the market. Buyers have less competition for homes, more time to decide, more listings with a price cut, and the return of more power in negotiations – including protections like financing and inspection contingencies.
In addition, there are now more local down payment assistance programs for buyers who qualify.
Lastly, some home lenders can now use on-time rent payments in their lending criteria.
What can we expect in 2023?
Mortgage rate movements are nearly impossible to predict. Rate movements depend on a huge number of factors: the Fed’s actions, their statements, how markets interpret those, geopolitical concerns … the list goes on. However, there is a general consensus that there will be continued upward pressure on rates this year.
While it is very difficult to predict where mortgage rates will go next, rising rates have sidelined potential home buyers and potential sellers. A sharp reduction in mortgage rates would likely reenergize activity in the housing market and incentivize some buyers and sellers who are currently on the fence to jump back into the market.
Overall affordability challenges could persist as housing deficits persist in many parts of the country, but it’s likely that many potential buyers – particularly first-time buyers who have faced an extraordinarily competitive market over the past couple years – would view lower rates as an opportunity to finally enter the market.
On the sellers’ side, some price adjustments will be necessary. However, most sellers can still sell their home for way more than they would have a year ago or before the pandemic.
A large dip in mortgage rates could help unlock those who are concerned about giving up their current rate for a higher rate.
Paul Thomas, Vice President, Zillow Mortgages Capital Markets, issued a statement on Oct. 19 which said investors will be evaluating comments from Federal Reserve Bank presidents to gain further insight into likely Fed actions at upcoming meetings.
“Price indexes for both producers and consumers released last week forced markets to adjust for the likelihood of further Fed actions to control inflation, now pricing in a 75-basis point rate hike at the November FOMC meeting,” Thomas said.
Thomas said markets continue to be extremely volatile in reaction to economic data and geopolitical activity, particularly in the UK.
Higher mortgage rates are putting pressure on housing activity, Thomas said.
Purchase applications are now at their slowest pace since 2015 – 40% slower than a year ago – according to the Mortgage Bankers Association.
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