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U.S. housing prices could plunge 20%, Dallas Fed warns

30-year fixed mortgage rate climbs again
30-year fixed mortgage rate climbs back to two-decade high 04:00

America's home prices could plunge as much as 20% due to the sharp rise in mortgage rates in 2022, which are drastically increasing home ownership costs and "boost the odds of a severe house price correction," according to research from the Federal Reserve Bank of Dallas.

To be sure, the potential for the nation's homes to shed as much as one-fifth of their value represents a "pessimistic scenario," Dallas Fed economist Enrique Martinez-García noted in a report on Tuesday. But other economists have signaled similar fears, with Pantheon Macroeconomics Chief Economist Ian Shepherdson earlier this year predicting a similar slump in home prices.

The pandemic created an unusual elixir for the real estate market, with record-low mortgage rates and work-from-home orders whipping up a surge in demand for home ownership. At the height of the market, some buyers even waived traditional contingencies such as inspections and offered tens of thousands of dollars over asking prices in order to win their bids — a "fear of missing out" mentality that fed into a "bubble," Martínez-García said.

A steep decline in housing prices would likely have a ripple effect on the broader economy as well as further undermine the real estate sector. If home prices dropped 15% to 20%, under Martínez-García's pessimistic scenario, personal consumption could drop by 0.5 to 0.7 a percentage point, he estimated. 

"Such a negative wealth effect on aggregate demand would further restrain housing demand, deepening the price correction and setting in motion a negative feedback loop," he cautioned. 

High mortgage rates drive down home sales 02:09

Mortgage rates have jumped from about 3% in January to about 7% currently, moving in tandem with the Federal Reserve's six rate hikes this year. The central bank wants to tame the highest inflation in 40 years by raising the cost of borrowing, which should temper demand from businesses and consumers. 

Ideally, the Fed will "carefully thread the needle of bringing inflation down without setting off a downward house-price spiral — a significant housing sell-off that could aggravate an economic downturn," Martínez-García wrote.

Home prices rose a total of about 61% between 2013 and 2022, after adjusting for inflation — a jump that outpaced the previous housing bubble from 1998 to 2007, according to his calculations. 

Higher mortgage rates should decrease the risk that the current "boom" in home prices will continue, Martínez-García added. 

Demand rises for adjustable-rate mortgages 04:15

For now, housing prices are still rising. The national median price for an existing single-family home rose 8.6% in the third quarter, reaching $398,500, according to the National Association of Realtors. Still, the rate of price increases is slowing, given that home prices jumped 14.2% in the second quarter, the industry group said earlier this month

More buyers are getting priced out of the market because of the combination of rising home prices and higher mortgage rates. The median income now required to buy a typical home is now $88,300, or about $40,000 more than was needed prior to the pandemic in 2019, NAR said. 

The market is particularly tough at the moment for first-time buyers. Because of the spike in mortgage rates, a buyer of a typical starter home worth about $340,000 who put 10% down would face a monthly mortgage payment of $1,808 — about $600 more than a year ago, according to the group's calculations. 

NAR Chief Economist Lawrence Yun predicted earlier this month that home sales will slip by 7% next year as more people are priced out of the market, but said he expects the median home price will rise 1%. One reason he doesn't expect prices to slide: Inventory remains tight, meaning that buyers are still competing for desirable properties. 

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