The Federal Reserve’s rate hikes slammed the brakes on the housing market and may cause a recession that would lead home prices to plunge.
By Clare Trapasso
The U.S. Federal Reserve has completely upended the housing market, taking it from turbocharged to rapid deceleration.
The effects of the Fed's rate hikes in its war against inflation are being felt in just about every crevice of the economy, as recession fears are quickly mounting. The stock market keeps falling, companies are scaling back on hiring or letting workers go, and mortgage interest rates are rising even more than anticipated, causing homebuyers to slam on the brakes.
Home prices in many markets have even begun falling from their peaks. Now, the question is how far they will drop—and what fissures will be opening elsewhere in the economy to propel these changes.
The red-hot housing market will likely “have to go through a correction” as “housing prices were going up at an unsustainably fast level,” Jerome Powell, chair of the Federal Reserve, said in a press conference last week.
While economists debate whether the nation is already in a recession or heading toward a downturn, it’s clear that the housing market has shifted dramatically.
“The Fed is determined to cool inflation, and they’re willing to throw housing under the bus to do so,” says Devyn Bachman, senior vice president of research at John Burns Real Estate Consulting. “When you raise [mortgage] rates to the point they’re at today, it breaks the back of housing.”
A year ago, homes were selling in mere hours as throngs of buyers tried to outbid one another by tens, if not hundreds, of thousands of dollars over the asking price. However, when the Fed began raising its rates, mortgage interest rates also went up, making it significantly more expensive for buyers to afford housing.
So home prices have begun coming down from the summer, and many would-be buyers aren’t purchasing homes. Sellers, realizing they missed the peak, are holding off on listing their homes. Many who need to sell are cutting prices.
“The deceleration in housing prices that we’re seeing should help bring … prices more closely in line with rents and other housing market fundamentals—and that’s a good thing,” Powell said last week. “For the longer term, what we need is supply and demand to get better aligned so that housing prices go up at a reasonable level, at a reasonable pace, and that people can afford houses again.”
Some fear the Fed’s course of action could be too much for the housing market to withstand. Prices have been falling from a peak in June. And while prices are still up from a year ago, many real estate experts predict they’re about to fall much further.
Mortgage rates have more than doubled in the past year, rising from an average of 2.87% this time last year to 6.7% for 30-year fixed-rate loans in the week ending Sept. 29, according to Freddie Mac. Those higher rates have made monthly mortgage payments about 74% more expensive than they were this time last year.
“The housing market is the most interest-rate-sensitive sector of the economy,” says Mark Zandi, chief economist at Moody’s Analytics. “It’s on the front lines of the fallout from the Fed’s efforts to bring down inflation.”
Buckle up: Home prices are expected to fall
Home prices are expected to fall—whether the nation succumbs to a recession or not. Buyers simply can’t afford the giant price tags plus the highest mortgage rates in 15 years.
“There’s going to be a coast-to-coast downturn in the housing market. It’s going to be brutal,” says Zandi. “No part of the market is immune.”
Places that experienced the biggest run-ups in prices during the COVID-19 pandemic, with the most investors bidding them up further, will see the steepest declines, say real estate experts.
Vacation areas will likely see larger declines as fewer buyers are likely to buy second homes during an economic downturn. Areas with a lot of new construction, smaller cities, and farther-out suburbs could also take a big hit.
“Pricing declines are going to happen, likely in the double-digit range,” says Bachman of John Burns. “We may see pricing corrections that are similar to those that occurred during the great financial crisis in certain markets.”
She expects markets like Austin, TX; Boise, ID; Phoenix; Salt Lake City; Riverside, CA; and Sacramento, CA, to be affected.
Zandi believes home prices will fall about 10% nationally over the next 12 to 18 months if the country avoids a recession. If one happens, he anticipates price declines could approach 20% from peak to trough in 2024.
“Prices have to come down quite a bit to make it affordable with these mortgage rates,” says Zandi.
They won’t come down immediately.
Sellers won’t drop prices unless they have to—especially as they watched their neighbors’ homes sell for record prices just a few months earlier. While about 19.5% of sellers cut prices in September, a percentage that has steadily been ticking up, the majority of sellers have held firm.
“Sellers are looking at prices from six months ago [but] buyers can’t afford those prices,” says Ron DeVries, senior managing director of Integra Realty Resources, a market research provider for commercial real estate. “There’s going to be a disconnect for a while.”
That disconnect is already resulting in fewer home sales—which experts believe will continue as the uncertainty in the economy grows. Existing-home sales, which exclude new construction, plunged 19.9% in August compared to the same time a year earlier, according to the most recent National Association of Realtors® data.
“It makes less sense to buy a home,” says Zandi. “House prices are high, mortgage rates are high, and there’s no inventory. And now people are worried about their jobs.”
Don’t expect more homes to go up for sale
The silver lining for buyers grappling with higher prices and rates has been more homes are now on the market. Inventory was up 26.9% in September compared to the same time last year, according to Realtor.com® data.
However, like everything else in the housing market, it’s a double-edged sword. It’s not that sellers and builders are putting more homes up for sale—they’re doing the opposite at the moment. It’s that homes aren’t selling as quickly, so what’s been listing is sitting longer, boosting inventory.
In fact, new listings were down 9.8% year over year in September.
Sellers know they’ve missed the peak of the market. Plus, most sellers are also buyers. Those who locked in lower mortgage rates will be reluctant to give those up to buy a new home as they could wind up paying a lot more for a lot less. That narrows the seller pool down to those who need to move.
“The reason why people do make a trade is generally because they have to,” says Jessica Lautz, NAR’s vice president of research. “If someone has a new job and they have to go into work or they have a growing family and they need more space that’s going to a bigger motivating factor than [mortgage] interest rates.”
Don’t expect another wave of foreclosures
However, there are still more people who need homes than there are homes to go around.
Rents are high and rising pushing more people into the for-sale market. And most real estate experts don’t expect another flood of low-priced foreclosures and short sales to hit the market, as they did in the housing crash.
Just 1% of realtors worked with a client going through a foreclosure or short sale in the last month, according to National Association of Realtors® data. However, 49% of realtors worked on these sales in March 2009.
“We’re in a completely different environment today,” says NAR’s Lautz.
Much of this is due to lenders only giving mortgages to the most qualified borrowers and the eradication of the really bad subprime loans that got borrowers in trouble during the Great Recession. Even if Powell’s projections are correct and unemployment rises from 3.7% in August to 4.4%, another tsunami of foreclosures is unlikely.
But if unemployment rises, fewer people will buy homes.
“If you think there’s a chance you’ll lose your job in the near term, you’re not going to run out and buy a house,” says Integra’s DeVries.
The one bright spot for the housing market is if the nation does fall into a recession, the Fed is likely to cut rates again to stimulate the economy. That’s likely to lead mortgage rates to fall again.
“Whether we go into a recession or not, it’s going to be uncomfortable,” says Zandi.
Clare Trapasso is the deputy news editor of Realtor.com where she writes and edits news and data stories. She previously wrote for a Financial Times publication, the New York Daily News, and the Associated Press. She also taught journalism courses at several New York City colleges.