Mortgage rates dropped this week for the second straight week — presenting a double-edged sword for homebuyers.
The average rate on the 30-year mortgage decreased to 7.5% from 7.76% last week, according to Freddie Mac on Thursday. That marked a more than a quarter-point drop, the largest one-week decline since November 2022.
While the recent softening of rates makes financing cheaper for homebuyers, it may also create a new set of challenges. More buyers may return to a still limited-supply market and push home prices higher as competition heats up.
“I think if interest rates drop, we’re going to have so much demand on the sidelines that comes into the market,” Dr. Jessica Lautz, deputy chief economist at the National Association of Realtors, told Yahoo Finance. “It could bid up home prices unless we have more housing inventory.”
Demand moves with interest rates
Many buyers who have mostly given up on buying a home in the last six months are waiting for rates to drop to return to the market. Nearly two-thirds of buyers are waiting for mortgage rates to fall before buying a home, a BMO survey of 2,500 people this summer found.
That was on display with the most recent drop in rates. Homebuyers pounced on the relief.
The volume of mortgage applications for a home purchase increased 3% last week on a seasonally adjusted basis from a week earlier after that quarter-point drop in rates, the Mortgage Bankers Association (MBA) reported Wednesday.
Still, the purchase application index remains off by 20% from last year’s levels, reflecting the worsening affordability that has occurred in just 12 months because of rates.
“While the median listing price in October 2023 stood at the same level as last year, elevated mortgage rates have resulted in a significant increase in the cost of financing a typical home for sale,” Jiayi Xu, Realtor.com’s economist, said in an email.
The increased monthly cost is more than $166, Xu found, up 7.4% versus the previous year. Additionally, it has raised the required annual household income for purchasing a median-priced home by $6,600, reaching a total of $120,000.
Another intractable problem remains inventory — caused by mortgage rates — because many homeowners locked in historically low mortgage rates during the pandemic that they’re reluctant to let go of.
“Even if rates come down a little bit, I don’t know that necessarily changes that dynamic of a shortage of supply,” First American chief economist Mark Fleming, told Yahoo Finance Live this week (video above). “Ninety percent of all mortgaged homeowners today have a rate below 6%. And I don’t think we’re going to see 6% anytime soon for a mortgage rate.”
That means if buyers rush in if rates get below 7%, the inventory won’t be there to meet that increase in interest, sending up prices and worsening affordability on that side of the equation.
“The total cost of housing is really important to keep in mind,” Lautz said.