Housing Market Decoded: Low interest rates were a blessing and a curse 

Decisions in residential real estate are often based on market data — sometimes conflicting, often confusing. Housing Market Decoded, authored by economists and other market experts, helps put the data in context so you can make sense of the numbers.

Who out there misses the good old days when 30-year rates were below 3% and all was right with the world? Of course, we all knew — or should have known — that it was not going to last forever. That said, the speed at which rates took off was rather shocking!

The pandemic, of course, had a profound influence on the housing market. Although financing did not become easier, it certainly became cheaper, and with households moving away from the epicenters of employment, a perfect storm occurred.

Existing home sales rose through the second half of 2020 eventually hitting a level in 2021 not seen since 2006. Furthermore, mortgage rates averaged just 2.96% — the lowest in the history of the 30-year mortgage. But, in hindsight, was the collapse in mortgage rates a good thing for the market as a whole or not?

Low rates initially made homes more affordable...

During the initial phase of rates falling, affordability rose as more households qualified for a mortgage and, according to the Atlanta Fed's Ownership Affordability Monitor, U.S. housing breached the affordability threshold a little before the start of the pandemic — something it had not done since early 2018.

Moreover, the share of total owner households rose to 67.9% in 2020 — a high not seen in over 14 years.

...but led to a surge in prices, pushing affordability down

But cheap financing and low inventory levels are a recipe for bidding wars, and that's what we saw. Existing home prices rose by an astonishing 18.2% in 2021, and even as rates started rising last year, home prices increased by 10.2%.

Was the pace of price appreciation a good thing? My answer is no.

The ratio between incomes and home prices rose from 3.3 at the onset of the pandemic to 4.8 when prices peaked in May of 2022 and, by the end of last year, just 38% of homes sold were affordable to families making the median income. This is a low not seen in the 18-year history of the NAHB Housing Opportunity Index. There are consequences for every action, and this is certainly true when it comes to the housing market.

While current mortgage rates have managed to hold below 7% since last November, many economists, myself included, still expect them to slowly retreat from current levels as we move through the year. But let me be very clear: Gone are the days of sub-3% 30-year financing.

Low inventory will keep prices from collapsing

Higher rates are straining affordability levels in a majority of housing markets across the U.S., which has led to lower listing prices. Inevitably, this will result in lower home sale prices this year.

That said, I see no circumstance that will lead to home prices collapsing in a manner reminiscent of 2008, and I can say this with confidence for one very simple reason: Inventory levels will remain remarkably low this year, and this will actually help support home values.

The impact of falling mortgage rates during the first two years of the pandemic was significant, but not at all unexpected. It created favorable conditions for first-time buyers who found that they were able to get their feet on the first rung of the housing ladder, as well as existing homeowners who refinanced and freed up money to invest in the economy.

But, as I mentioned earlier, there are always consequences. Those who were unable to take advantage of favorable financing are now faced with markedly lower affordability and the unlikelihood that prices will fall enough for them to get into the market.

Furthermore, real estate agents will face an uphill battle in 2023 and beyond as many homeowners will choose to stay put rather than sell and risk losing their low mortgage rate (at least until rates fall to a point where it becomes less compelling to stay put).

The good, the bad and the ugly of low rates

So, the "Good" that came from the artificially low mortgage rates was a temporary increase in affordability, an uptick in first-time buyers, and homeowners with more cash in their pockets after refinancing.

The "Bad" was their rapid rise from their historic lows. Affordability dwindled, banks and lenders made significant layoffs, and lending standards got tighter.

And the "Ugly"? Well, that is likely to come in the form of inventory levels that I simply do not see rising significantly in 2023. This will lead existing U.S. home sales to fall to 4.3 million units in 2023 — down from 5.1 million in 2022.

Given these circumstances, it should hardly be a surprise that home buyer sentiment remains fairly dour. In fact, the current level of Fannie Mae's Home Purchase Sentiment Index remains close to the all-time low seen last October.

Low mortgage rates have been a blessing and a curse but, when all is said and done, I, for one, do not wish to see them return to the historic lows of the past few years any time soon (if ever)!

Matthew Gardener is the chief economist at Windermere Real Estate, where he analyzes and interprets economic data and its impact on national and local real estate markets. He is also a member of several economic advisory boards and a lecturer at the University of Washington. The views expressed in this column are solely those of the author.