Buyers have been facing the painful one-two punch of high mortgage rates and rising home prices all year. Mortgage rates hit a two-decades high at 8% in late October, and have dropped only slightly.
However, mortgage rates slipped to a two-month low last week to 7.29%, somewhat of a welcome sign for buyers and sellers waiting on the sidelines to break into the housing market. But housing affordability is still the worst it’s been in decades thanks to home prices that just aren’t letting up.
“The lock-in effect of so many people having mortgage rates they don’t want to lose well below current market rates is starting to have an impact,” Christopher M. Naghibi, executive vice president and chief operating officer at First Foundation Bank, tells Fortune. With so many people who might otherwise sell and move stuck in place by their too-low-to-give-up mortgage rate, he says, “we are in a bit of an unprecedented and precarious position in the market.”
Some housing experts and economists, though, predict that home prices could decline next year, which could help thaw a housing market in a deep freeze where existing home sales have dropped to their lowest levels in 13 years. Morgan Stanley forecasts a 3% average drop in home prices next year as the “growth in inventory offsets the increased demand,” strategists Jay Bacow and James Egan wrote in the note released last week.
There are some indications the thaw is already starting. Wells Fargo senior economist Charlie Dougherty tells Fortune that “there are some recent signs that homebuying activity is beginning to defrost,” including a drop in mortgage rates and an increase in mortgage applications. “Mortgage applications remain low, but the recent upturn is an encouraging sign that lower mortgage rates are starting to breathe new life into the housing market,” he says.
Zillow also subscribes to the narrative that home prices may not rise as much as expected, having adjusted its Zillow Home Value Index to grow 3% in 2023, down from an expectation for 3.3% growth in last month’s forecast. One reason for the downgrade is “mortgage rates that have remained elevated,” a Zillow research report says. “However, recent inflation data has shown promising signs for the future of mortgage rates.”
According to Naghibi, of First Foundation Bank, the utterly unaffordable nature of homes today is the leading candidate to (eventually) drive home prices down.
“If people can’t afford to buy, they don’t buy. If they don’t buy, values drop,” Naghibi says. “It isn’t rocket science.”
Naghibi notes that it’s difficult to measure housing market demand when so few people can feasibly afford a home. Homeownership has gotten so expensive, between high mortgage rates and high property prices, that the average monthly mortgage payment has shot above $2,500 for the first time in history, according to real estate analytics company Black Knight’s Mortgage Monitor. Surging mortgage rates this summer pushed monthly payments up 60% from the year before, as of this summer, boosting the average monthly payment by $870 and leaving one-fourth of homeowners paying $3,000-plus a month.
Home prices have been on a seven-month growth streak, increasing nearly 6% since January, according to the Case-Shiller U.S. National Home Price Index, which measures the change in value of U.S. single-family homes month to month. Now that the average cost of a home in the U.S. is $311,500, Redfin CEO Glenn Kelman thinks that a drop in home sales prices “seems not just possible, but likely.”
“The market has just been frozen because buyers and sellers can’t agree on a price,” he said in a Fox News interview last week. “For the first time, there’s a break in the logjam where we might see a real drop in prices, and that is going to spur sales.”
Economists split on where home prices are headed
As Naghibi explained, the lock-in effect has chilled existing home sales in the U.S. With fewer homes on the market and more competition among buyers, home prices have gone up.
“There are strong pressures in the housing markets both ways. Reluctance from homeowners to sell and ‘give up’ their low-rate mortgages is reducing the inventory and driving prices up,” economist Aleksandar Tomic, who also serves as associate dean for strategy, innovation and technology at Boston College, tells Fortune. On the other hand, “rising interest rates and related unaffordability of housing is forcing potential buyers out of the market, putting downward pressure on prices.”
But Tomic also points to other economic factors that could drive down home prices, such as interest-rate cuts from the Federal Reserve, or, more ominously, an increase in layoffs and unemployment forcing homeowners to sell.
“Morgan Stanley is betting on rate cuts to fuel demand for housing, but these cuts are dependent on slowing down the economy,” he says. “If this happens, prices will likely fall, but I would predict it would be more precipitous than 3%.”
Wells Fargo still forecasts that home prices will rise, and the most likely way that home prices would decline is if there were a “material increase in inventory,” Dougherty says.
But even a slight decline in prices can only do so much. Housing affordability is a multifaceted issue that won’t be solved by lower existing-home prices alone.
A housing price correction “is not as catastrophic as people make it out to be. Sadly, this alone will not solve the affordability issue,” Naghibi says. “That would take a combination of wages increasing, rates dropping, and home values dropping.”
