As House Prices Start To Moderate, How Bad Could It Get?

There is no shortage of pessimism in the housing market today. U.S. house prices have declined since June. However, prices are generally up year-on-year, and the market is seasonal with prices and activity typically higher in the summer and lower in winter.

Affordability is at very low levels, especially on the West Coast. We haven’t seen major house price declines yet, but there’s a fear it could be coming.

Housing Affordability

There are reasons to worry about the U.S. housing market. The dramatic spike in U.S. interest rates in 2022 is making housing affordability worse. Last year it was possible to obtain a 30-year mortgage for around 3%, now the same mortgage costs almost 7%. We’re seeing the highest mortgage rates in more than a decade.

Even aside from recent trends, house prices have climbed much faster than incomes in recent years and now mortgage costs are rising too. This means the average family buying a home today, is spending a lot more of their budget on housing costs when you factor in current mortgage rates. This trend varies by region. Houses are much less affordable on the West Coast, but affordability is far less of an issue in the Midwest.

Seasonality

As we head towards winter, it’s typical to expect a softer housing market based on seasonal patterns. House pricing typically peak in June for the year, and then fall back over the winter months. That’s what we’ve seen in 2022 so far too. Perhaps what we’re seeing currently is nothing more than a seasonal trend.

However, many industry commentators are skeptical. For example, Fannie Mae tracks housing sentiment and only 19% of people believe now is a good time to buy a home, and a majority think now is a good time to sell. Those are historically low numbers. That very little optimism concerning the U.S. housing market.

What Next?

It’s important to note that we’re nowhere close to any sort of housing crisis currently. For example, Zillow data has home prices up 13% year-on-year for September 2022. House prices have fallen back month-over-month, but remain up year-over-year. 2022 is hardly a bad year for housing at this point, especially compared to how the stock and bond markets have traded.

A few things could change the housing market picture.

Lower Rates?

The first is interest rates, which have risen aggressively in 2022. If rates fell back then affordability would improve. Currently, the Fed isn’t expected to cut rates sharply, but it may at least pause rate hikes in 2023. A recession could cause the Fed to cut rates, especially if inflation came under control. Lower interest rates would improve housing affordability, through reduced mortgage costs, and create less of a drag on the housing market.

Closing The Affordability Gap

Obviously, the real concern is that falling house prices are needed to bridge the affordability gap. On the Atlanta Federal Reserve’s assessment, affordability of housing currently looks similar to before the housing crisis of 2007-8. That’s a worry because it took around 20% fall in house prices to close the affordability gap during that period and prices were still soft for a few years after that.

It’s easy to see why there is concern about the housing market, especially on the West Coast. Housing affordability is at very low levels, driven, in part, by the recent spike in mortgage costs.

It’s possible that falling house prices are needed to close the affordability gap. However, if the Fed eased back on rates and U.S. incomes continued to increase over the coming years, that may also go some way to resolving the current affordability issues the U.S. is seeing. Still, we should note that house prices for 2022 are still generally up year-on-year and that housing affordability issues are far more acute on the West Coast than nationally.