Fed hikes and default fears: Here’s what could be next for the housing market

Homebuyers and renters alike may feel some relief later this year as house prices stabilize, mortgage rates fall and rental growth continues to slow.

Economists expect the Federal Reserve to hold off on rate hikes for a while while it observes incoming economic data, some stemming from the banking crisis that led to tightened lending.

This could allow mortgage rates to fall even further from their peak last fall and give buyers a little breathing room to take advantage of home prices falling from their peaks.

But first, Congress must avert a crisis and act on the debt ceiling to avoid an unprecedented default – an event that could shatter the US financial system, experts say.

The debt limit towers over the housing market

A US debt default could be devastating for homebuyers as economists predict already high purchase costs will rise by double digits.

In this unprecedented worst-case scenario, the market would effectively freeze while mortgage rates rose and home sales plummeted.

Home buying costs could rise by 22 percent as mortgage interest rates sail past 8 percent in defaults, according to a new analysis from real estate company Zillow.

“Broadly speaking, it looks a lot like the impact of what happened early last year, when mortgage rates rose significantly from just over 3 percent – up several points in about half a year. That pulled the housing market way off, that reversed it from price growth at declining prices, Tucker said.

But Tucker said a slowdown in home sales would be a bigger factor.

“In our forecast of what will happen in that default represents, in our estimation, 700,000 fewer home sales in the year and a half after that default,” Tucker said, adding that this presents hundreds of thousands of people on both sides of the transaction who are left out of the market.

Still, the US has never defaulted on its debt, and housing affordability may be spared another blow.

What you can expect for mortgage interest rates

The Fed’s rapid run of rate hikes over the past year has dramatically affected mortgage rates, which hit historic lows early in the pandemic and fueled a buying boom.

Monetary tightening from the central bank via interest rate increases trickled into the mortgage market and pushed interest rates up.

Higher mortgage rates combined with tight inventory and soaring purchase prices hindered affordability for many buyers, especially younger buyers looking for their first home.

But as soon as volatile interest rates have subsided after reaching their high mark of 7.08 percent late last autumn, and the benchmark rate remains high. After falling for the third week in a row, the average 30-year fixed-rate mortgage hovers just below 6.4 percent.

“This week’s decline continues a recent sideways trend in mortgage rates, which is a welcome departure from the record increases last year,” said Sam Khater, Freddie Mac’s chief economist.

“Although inflation remains high, the rate of growth has moderated and is expected to slow during the remainder of 2023. This should bode well for the development of mortgage rates over the long term.”

Several economic forecasts show that the 30-year fixed rate will fall to the low 6 per cent towards the end of the year. Data from the Mortgage Bankers Association estimates that interest rates could fall to as low as 5.5 percent.

Will there be more rate hikes at the Fed?

Federal Reserve Chairman Jerome Powell said early in the central bank’s series of rate hikes that the housing market must go through a correction to make housing more affordable.

Home prices cooled significantly over the past year along with inflation, and economists expect the Fed to hold off on further increases.

Zonda’s chief economist Ali Wolf told The Hill that it’s likely the Fed is done raising interest rates, at least for now.

“Fed officials have communicated that they want to track how their ten hikes so far affect the economy, especially since there is often a lag between higher rates and changes in economic growth,” Wolf said.

“However, if we see stronger than expected employment statistics or inflation numbers, Fed officials may feel the need to raise interest rates again,” she added.

Inflation cooled in April, reaching the lowest annual rate increase since 2021, according to the consumer price index (CPI) released this week.

Zillow’s Tucker added that the Fed may take a break from hikes as it continues to assess the fallout from several regional bank failures.

“I think they’ll probably spend some time watching the financial system digest the fallout from the recent bank closures and trying to understand how the credit channels that come from that actually start to constrain credit a little bit,” he said.

Rents are on track to continue falling

Requests for rent decreased for 11^th month in a row in April, an increase of just 0.3 percent, data from real estate agency Redfin showed. At the same time a year ago, median requests rose by more than 16 percent.

Declining price growth is largely due to the high number of units coming onto the market. Completions of buildings with five or more units rose 60 percent year over year in March to 484,000 on a seasonally unadjusted basis. And this rapidly increasing activity has pushed the vacancy rate to 6.4 percent—the highest level in two years.

Redfin Deputy Chief Economist Taylor Marr told The Hill that he expects rent appreciation to continue, but without offering much more financial wiggle room for renters.

“Rents are expected to move sideways into the second half of the year, avoiding large increases but mostly not providing much more savings to existing tenants,” Marr said in an email.

“The increase in supply (eg new multi-family construction) is expected to slow by the end of the year, and demand remains stable – well below the increase during the pandemic as many new rental households were formed,” he added.

Another rental trend economists noticed was the decline in rental growth as measured by the CPI.

RealPage senior vice president and chief economist Jay Parsons wrote in an analysis after the CPI’s release that while rent growth fell just 0.1 percent from last month, it’s the direction that matters.

“This is a big deal for inflation and interest rate watchers (including condo investors) because rents are the biggest variable in the CPI’s biggest category: shelter,” Parsons wrote.

Shelter, which accounts for around 40 per cent of core inflation, rose 0.4 per cent month-on-month in April and was the biggest contributor to the overall monthly rise in inflation.

What’s in store for house prices?

House prices grew rapidly during the pandemic housing boom – with double-digit gains seen in some markets. But price growth slowed during the latter half of last year and into the spring buying season.

Moody’s Analytics expects the prices of detached houses to fall by 4 percent, according to a recent forecast.

Moody’s Analytics housing economist Matt Walsh said there are signs the worst may be in the rear view. Still, he expects sales volume to remain low in relation to the pandemic as recent data indicates a weaker home buying season.

But he added that prices could fall from their peak even as sales volume stabilizes.

“While a 10% decline in house prices is significant, the incoming correction will be a far cry from the crash that followed the housing bubble of the 2000s,” he concluded.