Will cutting rates fix the housing market?

Mortgage professionals are currently facing a challenging origination market, but merely reducing mortgage rates would not be the ultimate solution to appease markets as many believe. While lower rates could temporarily lower borrower costs or boost home purchases, they could also increase risks in the housing industry without effectively addressing core issues such as supply shortages and long-term affordability.

The housing industry in America is grappling with persistent inflation, geopolitical uncertainties, regulatory uncertainties, and an economy driven by wealth that is increasingly influenced by equity markets. Fear is now the main driver as investors find it difficult to assess risks amidst impending tariffs and their potential impact on inflation.

Affordability is under strain in many markets, with the broader economy being supported by a limited number of consumer pillars. For instance, just a small percentage of earners now account for over half of consumer spending. This dependence on fewer individuals makes the U.S. economy highly vulnerable. Even a slight reduction in spending by the top earners could lead to a significant drop in GDP, potentially triggering a recession. Any subsequent rate cuts would come too late to prevent damage to the housing sector.

Most homeowners, faced with current high rates, are reluctant to sell or refinance, choosing to stick with their low mortgage rates from the COVID-19 period. This reluctance, except in some regions like Texas and Florida, is keeping housing inventory scarce and prices stable, effectively stifling refinancing activities.

In this uncertain environment, volatility is prevalent and uncertainty has become the new norm. Policymakers need to steer clear of short-term fixes. Immediate relief measures could backfire in the long run, as the risks now extend beyond the economic realm to psychological factors. Institutions like the Federal Reserve (Fed) must provide confidence and consistency, as their actions hold equal importance to the policies they implement.

The assumption that a Fed rate cut will offer relief to lenders overlooks a crucial fact: the Fed does not directly control mortgage rates unless engaged in Quantitative Easing (QE), which is not the case currently. While the Fed influences interest rates by adjusting the Fed Funds Rate, this primarily affects short-term rates, not long-term mortgage rates tied to bond yields. This mismatch between market expectations and rate realities could lead to confusion among lenders, delays in transactions, and heightened risk exposure.

Moreover, if the Fed reduces rates too rapidly, it may trigger concerns about inflation, causing long-term yields and mortgage rates to rise. An alternative solution gaining traction is adjustable rate mortgages (ARMs), which are linked to short-term yields and can change over time. However, as seen in Canada during the COVID-19 era, a surge in ARM lending resulted in financial stress when rates reset higher. Lower short-term rates could spike variable rate mortgage production, posing systemic risks that may materialize years later.

While the notion of “Time” may seem simple, it could be the long-term solution to affordability and inventory challenges. Real incomes need time to grow, home prices must stabilize, builders should increase supply, regulations should ease, and lenders could enhance automation to boost productivity and reduce borrowing costs.

In conclusion, short-term fixes are unlikely to resolve the uncertainties in the U.S. market or shield lenders from volatility. Patience and perseverance are crucial in navigating the current challenges, as predicting market trends remains uncertain. Lenders should focus on managing costs, offering strong value propositions, and adopting automation to enhance consumer experiences and reduce origination costs. While lower mortgage rates may sound appealing, a strategic long-term approach is essential for the housing industry’s sustained health.