The housing market isn’t warming up to lower mortgage rates, despite a recent drop from 7.2% to 6.4%. Homebuyers aren’t responding, with mortgage purchase applications now 9% below last year’s levels, marking the lowest point in decades. The modest rate cuts aren’t enough to reignite demand, as rates remain significantly higher than during the 2018-2021 period when they hovered in the 3-4% range.
The situation is further complicated by record-high home prices, pushing the typical mortgage cost to over 40% of the median US household income in 2024. The average monthly mortgage payment stands at $2,700, with an annual cost of $32,400. With the median household income estimated at $80,300, this results in a mortgage burden ratio of 40.3%, a figure that’s simply unsustainable.
Historically, when housing affordability reached such critical levels, as seen in the early 1980s and the 2006 housing bubble, conditions improved. These improvements were driven by lower interest rates, increased wage growth, and in the case of 2006, a significant drop in home prices. There is hope that today’s affordability crisis will also pass, but how and when this will happen remains the big question.
There are three primary ways to improve housing affordability: lowering home prices, reducing mortgage rates, and increasing incomes. All three will likely need to work in tandem over the next few years to restore balance in the market.
Looking at income growth, while wages in America are on the rise, the pace has slowed compared to a few years ago. The Bureau of Labor Statistics (BLS) reports that 12-month weekly wage growth is currently at 3.5% year-over-year. This means it could take another four to five years of consistent wage growth before homebuyers start to feel any real improvement in affordability. Therefore, wage growth alone isn’t going to rescue the housing market in the short term.
As for mortgage rates, the recent drop to 6.4% hasn’t sparked buyer interest. Rates likely need to fall below 6% before we see any positive changes in the market, with a more significant impact expected only when they reach the low 5% range. Based on the Federal Reserve’s current rate cut trajectory, mortgage rates might dip below 6% by Q1 or Q2 of 2025, which is still about six months away. To reach the low 5% range, a further 200 basis points in Fed rate cuts would be necessary, projected to occur around June 2025. This means it could be another year before mortgage rates fall enough to make a real difference in buyer demand.
This leaves home prices as the most immediate and impactful lever for improving affordability. A significant drop in home prices would quickly bring buyers back into the market, as lower prices would reduce both down payments and monthly mortgage payments, making home purchases more attractive.
There’s substantial room for home prices to decrease, especially considering that inflation-adjusted prices are currently in the largest bubble of the last 130 years. Existing homeowners have built up a considerable amount of equity, which could be “given back” to buyers through meaningful price cuts.
Certain housing markets are particularly vulnerable to price declines, including Florida, Tennessee, Texas, Utah, Arizona, and Idaho. In these areas, home prices are at least 20% overvalued, and inventory levels have spiked above the long-term norm. This combination of overvaluation and increased inventory makes these markets prime candidates for price corrections in the near future.
While the exact timing and extent of price drops remain uncertain, it’s clear that significant adjustments are needed to restore affordability and stimulate buyer demand. With home prices historically high, mortgage rates still elevated, and incomes growing at a sluggish pace, the path to a balanced housing market will require patience and possibly some tough adjustments ahead.
