Battle breaks out in US housing market as declining affordability collides with ‘lock effect’

Of the existing mortgages, 91% have a rate of less than 5.00%. Getty Images

In a clash of opposing forces, the US housing market finds itself embroiled in a fierce battle. On the one hand, the deteriorating affordability resulting from a sharp rise in mortgage rates from 3% to more than 6% in 2022, after national home prices rose more than 40% during the pandemic housing boom, is exerting downward pressure on home prices. . On the flip side is the scarcity of existing inventory, exacerbated by the so-called “lock-in effect,” in which many homeowners are reluctant to buy and sell again, for fear of swapping from a 2% or 3% mortgage rate to one in the 6% range. to 7%, exerting upward pressure on home prices.

Housing economists say neither force should be ignored.

Rising mortgage rates in 2022 surprised many potential buyers, reducing their purchasing power and making home ownership less expensive. With mortgage rates doubling in such a short period, housing affordability (or better yet affordability) According to the Federal Reserve Bank of Atlanta reached levels not seen since the bubble’s peak in 2006. That affordability crisis translated into a house-price correction last fall, which packed the biggest punch in overheated Southwest and West Coast markets. This affordability crisis continues to leave many potential buyers on the sidelines, dampening demand and causing a slowdown in home sales.

At the same time, the housing market is under pressure due to the lack of available inventory. The lock effect, a term used to describe homeowners’ reluctance to sell their properties due to fear of rising mortgage rates, has resulted in a dearth of homes on the market. Homeowners, who have enjoyed historically low interest rates, are reluctant to give up favorable financing terms, creating a bottleneck in the housing supply. According to Realtor.com, the number of homes for sale in June 2023 was 26.2% lower than in June 2022, and 28.9% less than in June 2019. This limited inventory has fueled competition among buyers, and caused home prices to rise in the first . Half of the year – the strong seasonal part of the year – in most markets.

To better understand the “lock-in effect,” consider the fact that 91% of mortgage borrowers have an interest rate of less than 5%, including 70.7% with an interest rate of less than 4%. For homeowners, it doesn’t make sense to buy and sell a property right now with a mortgage rate of 6% or 7%.

It’s not just potential buyers and sellers who feel nervous; The fallout extends to real estate professionals who rely on transaction volume to make a living. With housing affordability rapidly deteriorating and available homes scarce, real estate agents and brokers are grappling with limited opportunities to facilitate sales and earn commissions. The dwindling volume of transactions has dealt a blow to their financial stability and has endangered the viability of some companies.

So who will win? Will strained affordability drive down national housing prices, or will a lack of existing inventory drive up national prices?

According to companies like Zillow and CoreLogic, national home prices have already bottomed out and are expected to continue rising over the next 12 months. They say the current scarcity of inventory leaves buyers with no choice but to raise prices.

Mark Zandi, chief economist at Moody’s Analytics, takes a different view. He expects housing affordability to improve over the next few years, as mortgage rates slowly skew from about 6.5% in 2023 to 5.5% in 2025, and with national home prices eventually falling about 8% from peak to trough. In other words, Zandi anticipates strained affordability to overcome inventory shortages.

In our thinking this [price] The weakness is going to show over the next three years, there’s no ramp event here, it’s more of a slower decline,” Zandi says. luck.

If, in any way, Zandi’s team is wrong and “prices turn out to be stronger than expected,” he contends, it will be because of the lock-down effect, as individuals choose to hunker down and inventory shortages continue to drive higher national housing prices.

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