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The Impact of Soaring Mortgage Rates on the Housing Market: Are Home Prices Set to Decline?

The housing market in the United States, particularly in Southern California, is experiencing a slowdown as mortgage rates continue to rise. This trend has led to a decline in home sales, a surge in inventory levels, and growing concerns among prospective buyers and sellers about the possibility of falling home prices in the near future. In this article, we will delve deeper into the factors contributing to the current state of the housing market, analyze expert forecasts, and explore the potential consequences of rising mortgage rates on home prices.

Rising Mortgage Rates and Their Effects

The housing market is sensitive to changes in mortgage rates, and recent increases in these rates have triggered a slowdown in the market. Mortgage rates began the year at historically low levels, hovering around 3%. However, they have steadily climbed over the past few months, reaching nearly 6% in the current market, according to Freddie Mac’s closely watched mortgage survey.

To put this in perspective, let’s consider a home with a median price of $760,000 in Southern California. With a 20% down payment, a 3% mortgage rate in early January would have resulted in a monthly mortgage payment of approximately $3,493, including property tax and insurance. However, as rates increased to over 6%, that same monthly payment skyrocketed to about $4,428. This significant rise in monthly payments has made homeownership less affordable for many prospective buyers.

Impact on Homebuyers and Sellers

As mortgage rates surged, homebuyers faced a dilemma: should they proceed with their home purchase despite the higher monthly costs or wait for rates to potentially stabilize? This decision has led to a noticeable decline in buyer activity in recent months. Some buyers who were initially in the market for a new home have chosen to postpone their purchases, hoping for more favorable interest rates in the future.

On the other hand, sellers have also been affected by the waning demand. In response to the decreased interest from buyers, some sellers have started to lower their list prices in an attempt to attract potential buyers. This adjustment in pricing is an initial step toward stabilizing home prices, but it has also raised concerns among homeowners about the possibility of their properties losing value.

Expert Forecasts: Are Home Prices Set to Decline?

At the beginning of the year, expert consensus suggested that rising mortgage rates would slow down the rate of home price appreciation. In other words, while prices would continue to rise, they would do so at a slower pace compared to the previous years of rapid appreciation.

However, recent shifts in expert forecasts indicate that a more significant slowdown or even a decline in home prices could be on the horizon. While many analysts still view a scenario of slower price growth as the most likely outcome, a growing number of prominent forecasters are now predicting sustained price declines, something that hasn’t occurred in more than a decade.

One of the key factors contributing to this shift in forecasts is the rapid increase in mortgage rates. As mentioned earlier, the rise from historically low rates to nearly 6% within a few months has had a significant impact on the affordability of homes for buyers. This, in turn, has dampened demand and could potentially lead to price corrections in the housing market.

Expert Opinions on Home Price Declines

Jordan Levine, Chief Economist at the California Association of Realtors, is among the experts who have adjusted their forecasts to include the possibility of home price declines. Levine believes that the California median sales price for all of 2022 will still see an increase of 9.7% compared to the previous year. However, this represents a sharp slowdown from the nearly 20% growth observed in 2021.

Looking ahead to 2023, Levine anticipates that the Federal Reserve’s efforts to combat inflation could result in a mild economic downturn. The combination of job losses and higher prices is expected to lead to a 7.1% decline in the statewide median price compared to this year, with similar declines in Southern California.

Capital Economics, an international economic research firm, and John Burns Real Estate Consulting in Irvine have also adjusted their forecasts to include potential home price declines in 2023.

John Burns Real Estate Consulting predicts that both national and Southern California prices will drop in the coming year, partly due to the firm’s assessment of an impending recession.

The Role of the Federal Reserve

One of the driving forces behind these forecasts of price declines is the Federal Reserve’s response to inflation. To combat rising prices, the Federal Reserve has taken steps to tighten monetary policy, which includes raising interest rates. As interest rates increase, borrowing becomes more expensive, leading to reduced consumer spending and a potential economic slowdown.

Mark Zandi, Chief Economist at Moody’s Analytics, suggests that even without a recession, home prices could experience declines if mortgage rates rise to a certain threshold. If rates rise meaningfully above 6% and remain at that level, Zandi believes that Southern California home prices may fall by around 5%, even without an economic downturn. With a recession, the decline could be as much as 10%.

While a recession remains a possibility, most experts believe it would likely be mild and not comparable to the severity of the Great Recession experienced over a decade ago. Several factors contribute to this view:

  1. Tighter Lending Standards: Unlike the early 2000s housing bubble, lending standards today are much stricter. Risky lending practices that led to widespread foreclosures and the financial crisis have been curtailed.
  2. Fewer Risky Loans: A larger proportion of homebuyers during this current housing boom have secured their mortgages through safer lending practices, reducing the likelihood of foreclosures and distressed sales.
  3. Millennial Homebuyers: There is a significant cohort of millennials in their early 30s who are entering the housing market for the first time. This group represents a substantial pool of potential homebuyers, which is expected to support the housing market.
  4. Seller Behavior: Most homeowners today are reluctant to sell their homes for less than their neighbors received only a few months ago. This behavior is expected to limit the extent of price declines.

It’s important to note that while forecasts are indicating a potential slowdown or decline in home prices, a complete collapse like the one witnessed during the Great Recession is highly unlikely.

The housing market’s sensitivity to rising mortgage rates has led to a slowdown in sales and an increase in inventory levels, raising concerns about the possibility of falling home prices. While many experts still believe that a slower pace of price growth is the most likely scenario, a growing number of forecasters are including the possibility of sustained price declines in their projections.

The Federal Reserve’s efforts to combat inflation by raising interest rates have played a significant role in these forecasts. As rates continue to rise, potential buyers are grappling with higher monthly payments, causing some to delay their home purchases. Sellers have also been affected, leading to price adjustments in an effort to attract buyers.

While experts anticipate a mild economic downturn, they do not foresee a housing market collapse akin to the Great Recession. Stricter lending standards, fewer risky loans, the presence of millennial homebuyers, and seller behavior are all factors expected to mitigate the impact of rising rates on home prices.

In conclusion, the current state of the housing market reflects the delicate balance between the effects of rising mortgage rates and the underlying factors supporting the market. As we move forward, close attention will be paid to how these factors continue to evolve and shape the future of home prices in Southern California and beyond.

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