Aspiring home buyers grappling with the most difficult housing market in nearly 40 years are finally seeing some relief.
Borrowing costs for 30-year fixed-rate mortgages dropped below 7 percent this week for the first time in four months, according to the housing-finance giant Freddie Mac on Thursday. Just six weeks ago, the average rate for those home loans peaked at 7.8 percent, a high not seen since 2000; now it stands at 6.95 percent.
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Pressure on the battered real estate market look poised to ease further. The Federal Reserve on Wednesday held off raising interest rates, extending its pause to three rate-setting meetings in a row, as its policymakers projected that they would cut their benchmark rate by 0.75 of a percentage point by the end of next year.
Investors see the move as confirmation that the central bank has ended its war on inflation and will take a more hands-off approach to guard against an economic downturn. For home buyers, the Fed’s decision should add momentum to an improved outlook, even though housing experts say meaningful mortgage-rate relief could still be months away.
Borrowing costs remain more than double what they were early last year, and real estate prices remain elevated. That has kept the inventory of for-sale home low because existing homeowners have more incentive to stay put if moving means taking on a costlier home loan.
But with rates starting to fall, there already are signs that buyers are rejoining the hunt. Mortgage applications, which in October sank to their lowest level since 1995, have been ticking up since, the Mortgage Bankers Association reported.
How did we get here?
The pandemic sent the housing market into overdrive, as Americans who were flush with cash and encouraged by low borrowing costs rushed to buy homes. Median home-sale prices surged by roughly 50 percent from the start of the pandemic to the end of last year, according to Fed data.
It wasn’t just real estate that overheated. Prices spiking across the economy prompted the Fed in the spring of 2022 to start raising interest rates in a bid to get inflation under control.
The effort has largely succeeded. Inflation has moderated, with prices climbing 3.1 percent in November over the previous year, down from a high of 9.1 percent in June 2022. But the Fed’s campaign has also helped foster the real estate conditions pushing would-be buyers back onto the sidelines.
How are mortgage rates set?
Mortgage lenders set borrowing costs by first considering what the federal government pays to those who buy 10-year Treasury bonds, a baseline that markets use to assess the risk of other investments. They add a premium to that rate to cover the extra risk of home buyers’ defaulting on their loans.
For most of the decade preceding last year, that premium — or “spread” — hovered around 1.5 percent. So in 2021, when the average payout on the 10-year Treasury bond was about 1.5 percent, most home buyers could secure a 30-year mortgage with around a 3 percent interest rate.
But starting a year ago, the spread started to widen and is now around 3 percent, double its typical level. The difference adds up to real money for borrowers: It translates into $352 more per month on a 30-year fixed-rate mortgage for someone who bought a $450,000 house with a 20 percent down payment, according to a Washington Post mortgage calculator.
Why are mortgage lenders charging borrowers so much extra right now?
Several factors contributed to this shift. A major reason relates to how lenders price home loans and account for the risk that borrowers will refinance their mortgages if interest rates fall.
The reason this is so important is that the U.S. real estate market is unique in the world for offering homeowners the option to renegotiate the terms of their mortgages if borrowing costs fall, notes Susan Wachter, a professor of real estate and finance at the Wharton School of the University of Pennsylvania. That privilege encourages borrowers to take out 30-year loans — another singular feature of the U.S. mortgage market — without fear of locking themselves into disadvantageous rates.
But the arrangement compels lenders to hedge against the possibility that falling interest rates will tear holes in their balance sheets. A borrower who refinances effectively strips a higher-yielding loan from the lender, which will struggle to find as profitable an investment amid the lower rates. The lender is “stuck with having to receive the money back when they don’t want it,” said Jacob Sagi, a finance professor at the Kenan-Flagler Business School at the University of North Carolina at Chapel Hill.
In short: Borrowers effectively are paying more for their mortgages now because lenders expect them to be paying less soon.
When will interest rates go down for borrowers?
The answer depends on the Fed’s course in 2024. Most economists expect the central bank to start cutting its benchmark interest rate in the first half of next year, a message further reinforced Wednesday.
Precisely when such moves translate into cheaper mortgages is up for debate. The Mortgage Bankers Association recently projected that the interest rate on 30-year mortgages would fall to 6 percent by the end of next year.
What effect will falling mortgage rates have on home affordability?
As mortgage interest rates track the Fed’s benchmark rate lower, borrowers can expect an added benefit from lenders trimming the premium they have been charging to cover the risk of refinancing. “The spread will narrow,” Wachter said. “There’s a double positive in our future for borrowers.”
But even as borrowing costs edge down, many current homeowners may remain unwilling to list. More than 82 percent of current homeowners have locked in mortgages with rates below 5 percent, according to Redfin data. Daryl Fairweather, the site’s chief economist, projects that listings will pick up next year, outstripping demand and causing home prices to fall by 1 percent.