US Housing Outlook: Rates and Supply in Tug of War

With interest rates on the rise, the once red-hot US housing market is finally showing signs of cooling. But while rising mortgage rates have put a damper on demand, they’ve also contributed to an already tight supply of single-family homes. Until home building accelerates, supply constraints should continue to provide some price support, even as demand moderates.

A Torrid Housing Market Brought to Heel

The US housing market is emerging from a period of price inflation not seen since the run-up to the global financial crisis. In 2021 alone, US housing prices jumped nearly 20% on a year-over-year basis, driven by low mortgage rates, surging demand—particularly by millennials—and work-from-home flexibility brought about by the COVID-19 pandemic.

But perhaps the single biggest driver of housing inflation has been a lack of supply. In recent years, the US has seen some of the lowest home inventory levels on record. This has led to frenzied bidding wars, with properties in hot markets routinely selling above asking prices.

Home Affordability Has Taken a Hit

With the Federal Reserve on a quest to snuff out inflation, however, the era of ultralow mortgage rates is over, with the national average for a 30-year fixed-rate mortgage north of 6%. That’s more than double the level registered in January 2021, and the Federal Reserve is telegraphing more rate hikes to come.

New homebuyers are bearing the brunt of tighter monetary policy. Coinciding with rising rates and higher prices, home affordability has quickly breached its historical average. Since the mid-1990s, just under 18% percent of median US family income has gone toward mortgage payments, on average, with much of that figure driven by housing inflation prior to the global financial crisis (Display). Now, new homebuyers are allocating close to a quarter of median US family income on mortgage payments—a dramatic increase over just the past nine months.

Deteriorating home affordability has, in turn, put a damper on demand, although the numbers vary widely by region and price point. Nationwide, existing home sales slipped for six consecutive months beginning in February, while additional cracks in the demand picture can be seen in the 7.7% of sellers who lowered their offering prices—a marked departure from the bidding wars seen last year.