Will cutting rates fix the housing market?

America’s housing industry is up against persistent inflation, geopolitical challenges, regulatory limbo and a wealth-driven economy increasingly sensitive to equity markets. Fear has become the driving force as investors are struggling to price risk amid looming tariffs and their potential effects on inflation.

Affordability has grown strained across many markets, with the broader economy being propped up by increasingly narrow consumer pillars. For example, just 10% of earners now drive over 50% of consumer spending. In other words, the health of the U.S. economy depends on less people, which makes for a highly fragile situation. Even a modest pullback in spending of only 20%, from the top 10% of earners, could trigger a $1.6 trillion drop in GDP, enough to tip the economy into recession. Even if that leads to eventual rate cuts, the damage to the housing ecosystem would already be done.

With current high rates, most homeowners have little reason to sell or refinance – opting instead to sit on their historically low mortgage rates from the COVID-19 era. With the notable exception of parts of Texas and Florida, this is keeping inventory tight and prices relatively firm, effectively killing the refinancing space. 

In this environment, volatility is the norm, and uncertainty has become the new operating condition. For a problem-solving mindset amidst uncertainty, policymakers must avoid short-term thinking. What seems like relief in the immediate could backfire in the long-term, because the risk extends beyond economics, it’s now psychological. In this environment, confidence and consistency from institutions like the Federal Reserve (Fed) matter just as much as the policy itself.

The current assumption is that if the Fed cuts interest rates, lenders will see relief. That approach overlooks a key fact: the Fed doesn’t directly control mortgage rates (unless it’s engaged in QE…which it’s not). The Fed’s primary means of influencing interest rates across the entire yield curve is by changing the Fed Funds Rate. This speeds up a rapidly slowing economy by forcing down the short-term rates, which in turn drive down the cost of borrowing for companies. But this doesn’t directly translate to relief for borrowers, especially when mortgage rates are tied more closely to long-term bond yields. For lenders, the mismatch between market expectations and rate realities might spark confusion, delay transactions, and increase exposure to risk.

To complicate matters more, if the Fed cuts rates too quickly, markets may panic about potential inflation, which in turn would send both long-term yields and mortgage rates up. 

An alternative, but equally challenging, solution emerging in response to the current environment is adjustable rate mortgages (ARMS). These are loans with interest rates that are set off of shorter term yields and can change after a certain period of time. We’ve already seen where this can lead in Canada, where a wave of ARM lending during the COVID-19 era triggered serious financial stress for both borrowers and lenders after rates reset much higher. So, while lower short-term rates could drive a large increase in variable rate mortgage rate production, that introduces systemic risk into a housing market that we might have to deal with 5 or 7 years from now.

As painful as this might be to read, the long term solution for affordability and inventory constraints could simply be, drum roll please, “Time”.  Time for real (i.e. inflation-adjusted) incomes to grow, time for home prices to stagnate for several years, time for builders to add supply, time for regulations to become less onerous, and time for IMB’s to implement the kind of automation that will enhance productivity and reduce borrowing costs.

In summary, short-term solutions being proposed will not resolve the uncertainty of the United States’ market conditions or protect lenders from volatility. This coming chapter calls for patience and persistence. There are far too many variables at play, and no one can claim to know where the market is headed. The best thing lenders can do right now is to prepare to weather the storm with a constant eye on costs, with a strong enough value proposition to continuously gain market share, and to take a “fast follower” approach to automation aimed at improving the consumer experience while decreasing cost to originate. So, while a drop back down to 3% mortgage rates might sound nice, a long-term mindset is going to serve the housing industry’s continued well-being more than any band-aid solution could.

Joseph Panebianco is the CEO & President, AnnieMac Home Mortgage

This column does not necessarily reflect the opinion of HousingWire’s editorial department and its owners.To contact the editor responsible for this piece: [email protected].