How Pandemic Influences and Federal Reserve Actions Shape Mortgage Rates

In the world of buying homes, there's a saying that goes, "Marry the house, date the rate."

by Faruk Imamovic
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How Pandemic Influences and Federal Reserve Actions Shape Mortgage Rates
© Getty Images/Scott Olson

In the world of buying homes, there's a saying that goes, "Marry the house, date the rate." It's a fun way of saying you should be all in with the home you choose, but don't sweat the mortgage rate too much since it can change.

You might be able to refinance to a better rate down the road. But with how crazy the housing market is right now, this advice is even more important. A lot of people are nervously waiting, hoping mortgage rates will drop so they can afford their dream home.

The Pandemic Housing Boom

Buyers fortunate enough to enter the market early in the pandemic experienced historically low borrowing rates, a scenario that dramatically changed as the Federal Reserve took measures to combat inflation in 2022.

This resulted in a spike in mortgage rates, reaching a 20-year peak that October. The shift has left a significant number of homeowners reluctant to relinquish the advantageous loan terms they secured, while prospective buyers observed their purchasing power diminish, prompting many to adopt a wait-and-see approach.

Current Market Dynamics

The housing market today is a confluence of anticipation and reality. Many prospective buyers, driven by the hope that mortgage rates will soon drop, are holding off on their purchases. This logic is not unfounded; the potential for lower borrowing costs could indeed make homeownership more accessible for many.

However, this anticipation overlooks a critical aspect of the housing market: the balance of supply and demand.

How Pandemic Influences and Federal Reserve Actions Shape Mortgage Rates© Getty Images/Scott Olson

Real estate experts highlight a phenomenon known as the "lock-in effect," where potential sellers refrain from listing their homes, satisfied with their current low mortgage rates.

A drop in rates, while seemingly beneficial for buyers, could paradoxically tighten the market further. Lower rates tend to boost demand, leading to increased competition and potentially higher prices. Over the past decade, this trend has been consistent: a decrease in mortgage rates often results in a decrease in available homes for sale, and vice versa.

Mike Simonsen, president of Altos Research, points out the immediate consequence of falling rates: a surge in demand that reignites bidding wars and exacerbates the challenge of low inventory. "Don't expect that lower rates are going to suddenly make it easier for you as a homebuyer," he cautions.

"We can see that the demand comes back in quickly, the competition heats up. Then we're right back into the bidding wars with low inventory and all of those challenges."

The Psychological Aspect of Waiting

The decision to wait for lower mortgage rates is often rooted in a simple calculation: the desire to minimize monthly payments.

With the current typical mortgage rate hovering around 6.87%, the difference in monthly payments can be stark compared to the rates below 4% enjoyed by two-thirds of American homeowners. This disparity makes the prospect of waiting for rate decreases highly attractive.

However, this mindset fails to account for the dynamic nature of the housing market. The equilibrium between buyers and sellers dictates the pace and character of the market. During periods of high demand, such as the pandemic housing boom, the supply of homes could not keep up, leading to intense competition and swift sales.

The expectation that an increase in active listings will automatically follow a drop in mortgage rates overlooks the reality that demand could quickly absorb this new inventory, leaving many potential buyers in the same precarious position.

Navigating the Market

In a landscape shaped by rising rates and the specter of future decreases, prospective homebuyers face a complex set of choices. For those considering whether to enter the market now or wait, the key lies in understanding not just the immediate financial implications but also the longer-term dynamics of homeownership and market trends.

Navigating this market requires a clear-eyed assessment of one's financial readiness, the local real estate environment, and personal circumstances. For buyers, it may be tempting to hold off on purchasing in hopes of capitalizing on lower rates.

However, this strategy comes with its own risks, including the possibility of prices escalating further or the rates not decreasing as much as anticipated. Alex Thomas, a senior research analyst at JBREC, highlights the intensity of demand waiting on the sidelines.

"There's just too many people that have been priced out that are waiting on the sidelines. I think that would overwhelm any increase in inventory that you'd see," he asserts. This underscores the competitive nature of the market, where any easing of rates could quickly be offset by heightened competition.

The Bigger Picture

The broader economic context plays a significant role in the housing market's future trajectory. The Federal Reserve's indications of lowering borrowing rates could, in theory, alleviate some pressure on mortgage rates.

Yet, the timing and magnitude of these changes remain uncertain, especially against a backdrop of an economy still grappling with inflationary pressures. Moreover, the issue of a housing shortage looms large over the discussion of rates and affordability.

Fed Chair Jerome Powell and other experts point to the supply side of the equation as a critical factor in addressing long-term housing market challenges. Increasing the number of homes available for sale would help balance the market more sustainably than fluctuations in mortgage rates.

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