As the Federal Reserve continues its fight against inflation, where mortgage rates end up next year is anyone’s best guess — literally.
Economists predict rates could land anywhere from 5.2% to 8% — potentially even higher than that — depending on a number of uncertain factors such as how quickly inflation fades and how the economy absorbs the Federal Reserve’s rate hikes next year.
The guessing game comes after the mortgage rate forecasts for this year were woefully off base, but what remains constant is that affordability challenges will continue to plague buyers into the new year — unless there’s a recession.
“Home shoppers who are buying a home in 2023 will need to get creative. They could do that by exploring neighborhoods that are more affordable yet further out in the suburbs, consider a new market entirely, or other types of financing options,” Danielle Hale, chief economist at Realtor.com, said. “It doesn't mean buying a home won't be impossible, but it will be challenging for buyers in 2023.”
‘Rates had never doubled in a year before’
Mortgage rates increased at their fastest pace in over 50 years in 2022, topping 7% earlier this month and far surpassing many housing analysts' earlier prediction of reaching 4% by the year end.
“Rates had never doubled in a year before,” Freddie Mac analysts said in their October quarterly forecast.
The rapid ascent — spurred by the Federal Reserve’s aggressive campaign to tame inflation – hurt the once-blistering housing market. Housing affordability slumped to its worst point in nearly 40 years, mortgage technology and data provider Black Knight found, as higher rates, elevated home prices, and tight inventory continued to deteriorate buyers' purchasing power.
Although the housing market has begun to cool down, signaling a correction, Realtor.com’s 2023 forecast indicates that a return to normal is nowhere near, citing a “gradual adjustment” that could last until 2025.
Where will rates go
Hale and Realtor.com forecast that in 2023 rates will average 7.4%, followed by early rate hikes in the first half of the year, and a slight retreat to 7.1% by the year-end. However, the soft downturn in rates won’t be enough to ease homebuyer affordability concerns, as incomes will remain out of pace with elevated home prices and rates.
Where rates will end up next year will largely depend on inflation and whether or not the U.S. slips into a recession, Mark Fleming, chief economist for First American, told Yahoo Money.
“Everything hinges on the Fed interest rate changes,” Fleming said. “The baseline scenario is something to the effect that the Fed continues to raise interest rates into next year, possibly in smaller increments that we’ve seen in recent increases … if that trajectory gets rid of inflation we could probably see interest rates somewhere closer to 8% by the summer.”
If inflation remains rampant in the summer, forcing more actions from the Fed, mortgage rates could surpass 8% by the fall, Fleming said.
Other housing economists are projecting that rates will have a softer landing. Freddie Mac estimates that rates will average 6.4%, while Fannie Mae estimates rates hitting an average of 6.8%. Goldman Sachs is aiming even lower, with the average 30-year fixed rate dipping to 6.2%.
Housing affordability will remain a top concern going into 2023.
Purchase demand is 41% lower than a year ago, according to the MBA’s latest survey of applications, as higher rates and home prices continue to eat away at buyers’ budgets. At last week’s rate of 6.58% – a household earning the median-income of $72,000 annually would spend up to 40.6% of their monthly wages to afford monthly mortgage payment, according to figures provided by Realtor.com.
Add to that the rising prices of all the basics: gasoline, food, and utilities.
In 2023, incomes are expected to grow 3.9%, according to Realtor.com, but they won’t be enough to offset home prices which are projected to increase 5.4%. That’s going to hike the typical monthly mortgage payment to $2,430, 28% higher than in 2022, pricing out even more would-be homebuyers.
“If we can’t get inflation under control, affordability will get even worse,” Fleming said. “A house price correction will not be enough to mitigate the damage done by a potential 8%-plus mortgage rate.”
The case for 5% mortgage rates
On the flip side, one economist argued rates could drop next year, especially if the U.S. enters a recession.
“We’re expecting a recession next year, so weakness in the economy will be most visible in a weaker job market,” Mike Fratantoni, chief economist and senior vice president for the MBA, told Yahoo Money. “That’s bad news for people that are going to be out of work, but for the broader economy, one impact of that is a slowdown will probably help the Fed bring down inflation.”
According to Fratantoni, if the Fed stops raising short-term rates early next year due to a recession, longer-term rates like mortgage rates will trend much lower by the year-end.
“We think rates will be down to about 5.2% by the end of 2023,” he said.
Additionally, a recessionary period will likely keep home prices relatively flat through to 2024 and homes on the market for longer, giving homebuyers an opportunity to negotiate deals or shop around.
“Home prices at the national level will likely be roughly flat and they’ll remain that way through 2024, so home prices won’t be racing away from them the way they were the last couple of years,” Fratantoni said. “Another benefit for homebuyers is that homes will stay on the market longer, there will be less bidding wars, and it will be less frantic.”
That is, of course, if they manage to keep their job during a recession.
Gabriella is a personal finance reporter at Yahoo Money. Follow her on Twitter @__gabriellacruz.