The line graph starting in 2000 shows a general upward trend in home prices that fell as we entered the financial crisis. home prices began trading upward again in 2012 and accelerated rapidly during the pandemic.

When Are Home Prices Dropping?

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by

Ryan Graves, CFA
in

Various factors are pushing housing to extremes that have not been seen in generations, if at all. Home prices are just off all-time highs, while mortgage rates are at the highest in over a decade. With mortgage rates increasing so quickly in 2022, people wonder when home prices will drop.

The line graph starting in 2000 shows a general upward trend in home prices that fell as we entered the financial crisis. home prices began trading upward again in 2012 and accelerated rapidly during the pandemic.

Ultra-low mortgage rates and a limited supply of houses fueled a rally in home prices and home equity. Home prices in the US rose 60% from the trough in 2012 to 2019. During the pandemic, the Fed cut rates to historic lows and began buying mortgage-backed securities, sending prices higher by another 30%.

  • There is a scorching demand from millennials as they finally come into their formative homebuying years. 
  • Supply is tight as we (as a country) did not build enough in the wake of the Global Financial Crisis. 
  • Mortgage rates are soaring as the Federal Reserve increases interest rates and stopped its QE program. 

Millennials are homebuyers now.

Millennials are now the largest generation and are solidly into their homebuying years, making up 37% of homebuyers in 2022. However, the largest generation, millennials, comprise only 17% of homeowners. 

Saddled with student loan debt while entering a poor job market, millennials struggled to find their financial footing. Because of those experiences, they marry later, start families later than previous generations, and buy homes later.

Millennials are the largest generation, and about 63% still have no savings for a home downpayment. However, older millennials are driving the demand for single-family homes. And as younger millennials shed student loan debt and marry, they will enter the market for single-family homes. 

We need more single-family homes.

Much like many supply chain woes of the pandemic, many current housing problems stem from the Global Financial Crisis. The housing boom and bust of the early 2000s led to chronic underbuilding and underinvestment in the supporting supply chain. Depending on where you look and how you define a home, the US is short 3-5 million homes.

The line chart shows the completion of single-family homes in the US. The chart peaks before the mortgage crisis and never fully recovers.

For years, builders have needed to bring more inventory to market to keep up with demand. With tight housing supply and historically low mortgage rates, demand surged. Ultimately you reap what you sew, and we did not sew very many homes after the Global Financial Crisis. 

Mortgage interest rates soar higher.

30-year fixed mortgage rates in percent, weekly. Graph starts in 2020 before rates fall to historic lows in early 2021. Rates skyrocket in 2022 as the Fed increases interest rates at the fastes pace on record.

It is not a secret that the Federal Reserve Bank is increasing interest rates quickly. The fed funds rate is a significant factor in determining mortgage rates, but there are other things affecting mortgage rates.  

The Fed is also winding down its bond-buying program (quantitative easing), which includes a considerable amount of mortgage-backed securities. The Fed’s launch of QE to gobble up mortgages brought rates down to historic lows. 

With the Fed ending its bond-buying program, it is now entering quantitative tightening. Quantitative tightening, or QT, is the winding down of the Fed’s balance sheet. So, the Fed is no longer purchasing mortgages.

There are a few things driving mortgage rates higher at the moment:

  • Higher interest rates
  • The end of quantitive easing
  • Few other investors are willing to step in and buy mortgage-backed securities.

If rates are going higher and nobody is buying mortgage-backed securities, mortgage rates are going to shoot up. 

Housing affordability plummets for first-time homebuyers.

$500,000 home 10% down payment 0.5% PMI Insurance and tax included 30- year fixed rate 30-year fixed-rate mortgage November 2021 at 3.09%: $2,389.96 November 2022 at 6.95%: $3,449.60

The Fed is trying to bring down inflation by going nuclear with its aggressive interest rate hikes. The Fed has increased rates by a record 0.75%–four times in a row this year. 

Increasing interest rates might cool inflation by cooling economic sentiment, reigning in the hot jobs market and the demand for housing. The higher borrowing costs have already significantly cooled demand, but prices remain relatively high.

Surging mortgage rates and high home prices mean housing affordability is crumbling. Furthermore, it’s doing so at the fastest pace anyone has ever seen. It’s not falling for just anybody, either. Housing affordability is declining the most for first-time homebuyers, who are predominantly millennials. 

Things are not likely to get more accessible for those unable to hop on the property ladder during the last few years. The Fed will likely keep rates elevated for some time, pressuring mortgage rates. Also, elevated interest rat