Housing Market’s Slide and Wells Fargo’s Warning
Resilient U.S. Economy, But a Housing Challenge
While the U.S. economy, as a whole, has showcased remarkable resiliency against numerous recession forecasts, the housing market paints a contrasting picture. The housing market is facing challenges due to mortgage rates hovering around 8%, coupled with substantial pandemic-driven increases in home prices, affecting housing affordability. Wells Fargo has sounded a warning about the potential for a housing market recession if mortgage rates remain elevated.
Mortgage Rates and Housing Contraction
The recent commentary from Wells Fargo, titled “Rising Borrowing Costs Stand to Tip the Housing Sector Back Into Recession,” highlights the concern. The bank points out that the residential sector, which initially improved in the first half of 2023, now shows signs of contraction as mortgage rates rise.
Revisiting the 1980s
Wells Fargo draws a parallel between the current housing climate and that of the 1980s. Similar observations have been made by Bank of America Research and First American. The 1980s were characterized by high mortgage rates as the Federal Reserve, led by Paul Volcker, battled double-digit inflation. Now, with high inflation, high interest rates, and millennials entering the housing market, echoes of the 1980s seem apparent.
Impact of Elevated Mortgage Rates
Wells Fargo’s senior economist, Charlie Dougherty, and economic analyst Patrick Barley, predict that an “interest rate environment” where rates stay elevated will likely reduce demand and constrain supply by discouraging new construction and discouraging prospective sellers who are holding onto their low mortgage rates.
Rising Borrowing Costs and Eroded Affordability
The economists point out that rising borrowing costs will further erode housing affordability. The National Association of Realtors (NAR) calculates that the average principal and interest payment for borrowers with a 30-year fixed-rate mortgage increased by 26% in August compared to the previous year.
Multiple Factors Affecting Affordability
High home prices, which have risen over 40% since the onset of the pandemic, have played a role in deteriorating affordability. Tightened supply, partly due to homeowners retaining their homes due to low mortgage rates in an under-built market, is also contributing to this issue.
Mortgage Rate Outlook
Wells Fargo anticipates that mortgage rates will move lower, but they will remain elevated compared to pandemic lows. The average 30-year fixed mortgage rate is expected to end this year at 6.94%. Next year, the bank forecasts it to be 6.39%, and in 2025, it will decrease even further to 5.70%.
Housing Market Outlook
The bank foresees worsened affordability in the near term due to elevated mortgage rates, which will subsequently weaken housing activity. Home prices will continue to appreciate at a slightly slower pace, with a 1.8% increase by the end of this year and a 2.5% rise in 2024. In 2025, Wells Fargo predicts a 4.4% increase in home prices.
Impact on Existing-Home Sales
Elevated interest rates have led to a “lock-in effect,” pushing existing-home sales to their lowest level in 13 years. However, the decline in these sales was somewhat expected, as housing is highly sensitive to interest rates.
The NAR’s Appeal to the Fed
Notably, the National Association of Realtors (NAR) recently urged the Federal Reserve to stop raising interest rates. This call is reminiscent of actions taken in the 1980s when homebuilders sent a piece of lumber to the Fed, seeking help to restore housing demand through lower interest rates.
Positive Signs Amid Challenges
Despite the challenges, underlying demand for homes remains strong, particularly as millennials enter their prime homebuying years. Supply is beginning to rise, and new-home sales have managed to weather higher rates, in part due to incentives offered by builders. Wells Fargo expects new-home sales to rise by 4% next year.