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Following two years of rapid home sales and escalating home-price appreciation, the hot housing market began to downshift last summer and is now at a crawl, thanks largely to a surge in mortgage interest rates. The rising trajectory of rate increases began in March 2022 when the 30-year fixed surpassed 4%. The 30-year fixed rate climbed to a 20-year high of 7% in October and has hovered in the mid-6% range throughout 2023.
As a consequence of interest rates that are now more than double what we saw in 2020 and 202src, coupled with a sharp downturn in buyer demand, home prices have been in decline. After two years of unprecedented sales activity, does this raise red flags that the housing market is on the verge of a crash?
Forbes Advisor asked several housing experts what their forecast is for the housing market in the next five years. While most experts predict homebuyer demand to eventually rebound, there are warning signs for what may lie ahead.
Are We In a Housing Bubble?
The Federal Reserve Bank of Dallas identified signs of a “brewing U.S. housing bubble” in a 2022 report. Though the sharp increase in home prices doesn’t indicate a bubble, the report found, there are other fundamental factors to consider. These include “shifts in disposable income, the cost of credit and access to it, supply disruptions, and rising labor and raw construction materials costs are among the economic reasons for sustained real house-price gains.”
When “there is widespread belief that today’s robust price increases will continue,” the housing market becomes unhinged from those fundamentals, the Dallas Fed report revealed. “If many buyers share this belief, purchases arising from a ‘fear of missing out’ can drive up prices and heighten expectations of strong house-price gains.”
Len Kiefer, deputy chief economist at Freddie Mac, doesn’t believe the U.S. housing market is in a bubble.
“A bubble has three defining characteristics: price growth is driven by speculation, bubbles are fueled by credit expansion, bubbles pop,” Kiefer says. “While house prices grew at record rates in 202src, the reasons for the increase was not primarily speculation or credit expansion, but rather record-low mortgage rates and a fundamental shift in housing demand.”
But what about people who bought a home during or before the pandemic who are now seeing their home values decline?
Keith Gumbinger, vice president of mortgage website HSH.com, says if you bought a home for $300,000 three years ago, you could have sold it for $500,000 last year but now can only command $400,000. Still, he’s hesitant to characterize this as a “bubble pop” or a “crash.”
“It is a ‘paper loss,’ but not an actual loss,” Gumbinger says.
How Is Today Different From the 2008 Housing Market Crash?
Among the differences between today’s housing market and the 2008 housing crash is that lending standards are much tighter now due to lessons learned and new regulations enacted after the last crisis. Essentially, that means those approved for a mortgage nowadays are less likely to default than those who were approved in the pre-crisis lending period.
“In the lead up to the Great Recession the housing market had been fueled by rapid credit expansion, increased leverage and household expectations for house-price growth that proved to be too optimistic,” Kiefer says.
Unlike a fixed-rate mortgage, an adjustable-rate mortgage’s (ARM) interest rate changes periodically after an initial fixed-rate period. Kiefer says that homeowners who took out ARMs leading up to the 2008 crisis got hit with payment shock once the interest rates reset and many couldn’t make the higher monthly payments.
This brings up another important distinction between 2008 and today—most borrowers now have fixed-rate mortgages, Kiefer points out. As a result, even though mortgage rates have doubled, current homeowners are seeing no change in their monthly principal and interest payments.
Another key difference between today’s housing market and the 2008 housing crisis is that many more homeowners today have equity in their homes, which can help them weather a downturn. By late 2009, nearly a quarter of U.S. homeowners were underwater, or had negative equity, in their homes, meaning they owed more on their mortgages than what they were worth.
Recent data revealed that nearly half of mortgaged residential homes in the United States are considered “equity-rich,” meaning that the combined estimated value of loan balances secured by those homes is at or below 50% of their property value. In fact, borrowers saw their equity increase by 7.3% in Q4 2022 compared to the year before, according to a recent CoreLogic report.
Warning Signs That Could Dampen the Housing Market
Experts say that the combination of high mortgage rates, inflated home values, lower buyer demand and a recession is a recipe for a challenging year ahead for the housing market.
“With mortgage rates at the highest level since the early 2000s and affordability at a record low, many potential buyers are priced out of the market or unwilling to buy a home in fears of home-price declines,” says Selma Hepp, deputy chief economist at CoreLogic.
On top of that, Hepp says many people who bought their house over the past two years and locked in ultra-low mortgage rates are unlikely to move anytime soon, putting additional strain on available inventory.
The Federal Reserve Is Slowing the Housing Market
The rise in mortgage interest rates is due, in some part, to the efforts of the Federal Reserve to tamp down inflation, which began surging in 202src and has since reached 40-year highs. The Federal Reserve has raised its federal funds rate—the interest rate at which depository institutions, such as banks and credit unions, trade federal funds—src0 times since January 2022 at the most aggressive pace since the src980s. And while the Fed signaled at its May 2023 meeting that it will pause rate hikes in the short term, more rate hikes are likely in store.
“The Federal Reserve’s continued actions to tame inflation and ongoing affordability challenges will slow homebuyer demand and purchase origination volume in 2023,” says Joel Kan, deputy chief economist at the Mortgage Bankers Association.
The Fed’s actions have a meaningful yet indirect influence on mortgage rates because Fed rate movements affect borrowing costs, which directly impacts mortgage rates.
What Would a Recession Mean for the Housing Market?
Economists at the National Bureau of Economic Research (NBER) describe a recession as a prolonged period lasting at least a few months during which there is a significant and widespread decline in economic activity.
Here are some other signs economists look for to determine when we are on the brink of or have entered recession:
Gross domestic product (GDP) experiences two consecutive quarters of contraction or decline.
High inflation and borrowing costs slow down spending.
Slowdown in manufacturing and trade sales.
Steady increase in job losses and a surge in unemployment.
Inverted yield curve between the src0-year Treasury and short-term bonds.
Despite the highest inflation the country has seen in 40 years, there is some good news in the economy: a strong labor market with the national unemployment rate hovering near ultra-low levels of around 3.5%, wages and salaries up over 5.src% from a year ago and resilient consumer spending.
Nonetheless, many experts believe the U.S. economy might enter a recession in 2023. As a result, they predict consumers will pull back on spending as businesses dial back on investments and cut jobs.
Some economists predict that if we enter a recession it will be relatively mild compared to previous recessions. Even so, they say the housing market will still feel the impact.
It’s also worth noting that the surge of first-time homebuyers who buoyed the housing market in recent years is already depleting. The National Association of Realtors (NAR) recently reported that first-time home buyers made up only 28% of purchases in March 2023, down from 30% a year ago. A recession would likely spook prospective first-time buyers even more and transaction activity would sink further.
“[I]f the economy weakens, many prospective homeowners will be unable or unwilling to take on a mortgage,” Kiefer says. He also expects to see home prices decline, particularly in those markets that experienced the most rapid increases in 202src and 2022.
And don’t forget about the impact of remote work. During the pandemic, remote work was a major driver of house prices in many markets. If a recession leads to significant unemployment, “employers may decide that they don’t need to offer as many remote work options, and those markets that benefited from a surge in remote-worker-driven demand may see a contraction in demand,” Kiefer says.
Why the Housing Market Will Probably Not Crash
In a recent NBC News interview with Chuck Todd, Diane Swonk, chief economist at KPMG, said the housing market is “crashing.” She cited the Fed’s rapid rate hikes and the cooling of the housing market due to inaffordability despite inventory constraints.
However, other experts disagree that these factors alone equate to a housing market crash—and don’t anticipate that current conditions will lead to one.
“Prices are still like 5% to 6% above where they were this time last year,” says Daryl Fairweather, chief economist at Redfin. “They’re down from earlier this year, but they’re still above what they were last year, so I don’t think that qualifies as a crash.”
Fairweather explains that if you’re a homeowner who bought your property in 2020 or 202src, you don’t have to worry. The value of your home is still higher than it was, even if it has seen some decline in value.
Another difference compared to the years leading up to the 2008 housing crash is that, over the past decade, buyers have put more money down on their homes. “Due to home-price growth, many [homeowners] now have significant accumulation of home equity, which serves as a financial cushion in case there is a recession or they lose a job,” Hepp says.
What Will Happen to the Housing Market After a Recession?
While economists have different projections for how likely we are to enter a recession and precisely when that might happen, they all generally agree that we’re headed for one.
So what does that mean for the housing market once the predicted recession is in the rearview mirror? Experts expect a reset.
“As the economy slows, longer-term rates, including mortgage rates, will begin to fall from current peak levels,” Kan says. “Combined with cooler home-price growth and demographic drivers, we expect more prospective homebuyers back in the market in the coming years.”
Hepp says that buyers will return, but demand will depend on how much mortgage rates decline and the level of severity of the forecasted recession.
“These would be all generations of buyers and income groups as we do continue to have a demographic tailwind that would help boost homebuyer demand, Hepp says. “[S]tabilization is expected at some point in later 2023 and into 2024, depending on what happens to mortgage rates.”
Low Housing Supply Will Remain an Issue
The country has an acute housing supply problem due to a combination of factors.
For one, declines in pending sales and fewer homes on the market are making housing inventory even tighter. These trends may continue, as homeowners who purchased at a low mortgage rate in recent years are likely staying put for the foreseeable future. NAR reports that buyers expect to remain in their homes for a median of src5 years.
Another reason for the tight housing inventory is that people are living longer. “Where earlier generations would have exited homeownership, Boomers keep going strong,” Kiefer says. “This keeps supply off the market.”
And construction of new homes has also seen a slowdown. “Housing supply is likely to remain constrained for the next couple of years due to the combination of still-low levels of for-sale inventory and slowing new construction activity,” Kan says.
Kiefer shares this view, seeing the housing supply issue as a long-term problem. “The housing shortfall has put pressure on housing markets and will likely be with us for years to come.”
Despite persistently high interest rates and elevated home prices, a lack of resale inventory is providing home builders a reason to be cautiously optimistic. In the latest National Association of Home Builders (NAHB)/Wells Fargo Housing Market Index (HMI) monthly report, home builders’ confidence in the housing market inched higher for the fourth straight month. The HMI index is on a scale from 0 to src00 and gauges the strength of the single-family housing market. A score below 50 indicates that U.S. homebuilders have a negative outlook.
The index rose by one point from 44 to 45 between March and April. “Currently, one-third of housing inventory is new construction, compared to historical norms of a little more than src0%,” said NAHB Chief Economist Robert Dietz in a press statement. “More buyers looking at new homes, along with the use of sales incentives, have supported new home sales since the start of 2023.”
“In today’s market, we’re looking at about a three-month supply of homes available for sale, which is about half of what we’d like to see normally,” says Rick Sharga, executive vice president of market intelligence at ATTOM Data. “And we still have pent-up demand based on demographic trends.”
What Homebuyers Should Do?
Prospective homebuyers are facing tough choices in today’s market. Predictions indicate that while inflated home prices will decline in the coming months, new home construction will continue to lag for the foreseeable future. If demand resurges, limited housing inventory could cause home prices to spike again, keeping homes unaffordable for many.
For some shoppers looking to buy a home now, this means moving away from big cities into more affordable metros. For others, it could mean stretching their budgets or compromising on house size or other amenities.
“[W]hile it may be a difficult time for prospective homebuyers right now, the market conditions are much less competitive [than] they were earlier this year,” Hepp says. “[This] offers an opportunity for buyers to come in and not have to compete with other buyers and potentially even get a discount off the list price.”
On the other hand, what if you’re not ready to buy a home right now? Is there anything you should be doing to prepare for when you are ready to get back onto the house-hunting trail?
“Bulk up your savings, build your credit strength and research towns and neighborhoods which may suit your needs,” Gumbinger says.
However, don’t assume you’ll be able to time the market and guess when mortgage rates will hit their lows, which is a difficult practice, says Kiefer. “Instead, I would encourage prospective buyers to take a long-term view and consider what their housing needs look like today and may look like in the future.”
Kiefer says to consider your current credit score and what you might be able to do to improve it, and assess if you have sufficient savings for a down payment. He also suggests beefing up your borrower education through programs such as Freddie Mac’s CreditSmart.
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