Investors hoping that the recent U.S. Federal Reserve rate cut will translate into a significant drop in mortgage rates—and a corresponding lift to the housing market—may be slightly disappointed, according to Morgan Stanley Research.
“Home buyers need to understand that 30-year fixed mortgage rates are not priced off the Fed funds rate,” says James Egan, co-head of Securitized Products Research at Morgan Stanley. “For context, the Fed funds rate remained steady from the fourth quarter of 2023 until the rate cut in September, but in that time, 30-year mortgage rates dropped 180 basis points.”
The drop in mortgage rates is good news for potential home buyers. However, while lower rates and improving affordability are expected to help increase transactions in the housing market for the remainder of 2024 and into next year, sales and purchases are unlikely to reach levels seen in previous cycles.
“There are key differences from past periods that are affecting the overall housing supply, which means the growth in home sales volume will be more subdued for now,” says Egan. Here’s what investors should keep in mind.
Assessing Affordability
As of Aug. 22, 30-year fixed mortgage rates stood at around 6.5% down from a peak of nearly 8% in the fourth quarter of last year. Meanwhile, home affordability (as measured by monthly mortgage payments relative to income) had improved around 12% over that same period. (As of early October 2024, 30-year fixed mortgage rates were around 6.1% according to data from the Federal Reserve Bank of St. Louis.)
"This quantum improvement in affordability has only happened a few times in the past four decades. In most other years, a rise in affordability at this scale would lead to healthy growth in home sales over the next year or two," says Egan.
In the last 40 years, for instance, in periods when affordability improved at least 10% year over year, home sales rose by between 3% and 26% in the two subsequent years, with an average increase of 16% and a median increase of 18%.
However, this cycle is likely to be different. “While we expect home sales to increase, we think growth will be modest relative to these historical examples, at around 5% in the coming 12 months,” says Egan.
Lid on Supply
Foremost among the differences from past periods is the dearth of available homes. Inventory is at a historical low, with housing turnover close to its slowest rate in 40 years. This lack of supply has kept home prices climbing, putting affordability under more pressure than in previous periods.
"We simply have never had so few homes for sale as we do right now, compared with other periods of affordability improvement," says Egan.
Holding On to Houses
Adding to the pressure, high mortgage rates have created a "lock in" effect for homeowners who secured lower rates, especially during the pandemic. Despite the latest drop, the prevailing mortgage rate is 2.5 percentage points higher than that for most existing loans, meaning homeowners are reluctant to refinance or sell their homes if they don't have to. Indeed, more than 80% of borrowers' current mortgage rates are lower than the prevailing rates.
"We're still pretty far away from rates unlocking significant inventory," says Egan.
