Exactly one year after the Federal Reserve began raising interest rates last March to slow down inflation – after slashing it to zero in March 2020 – home prices fell for the first time in 131 months.
With that, the longest price growth streak on record was halted as the median existing-home price for all housing types declined 0.2% to $363,000 in February from a year ago, according to data released Tuesday by the National Association of Realtors.
So, far the Fed has hiked the federal funds rate eight times to a range of 4.5% to 4.75%. On Wednesday, it might do so once again as it pushes toward a projected target rate of 5.1%.
The pandemic housing market boom, which saw home prices go up by 40% over a two-year period, began slowing down in the second half of the year as mortgage rates doubled compared to the beginning of the year.
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How has the Federal Reserve’s rate increases affected the housing market?
“The Fed is actually very effective at speeding up and slowing down the housing market, almost too effective,” says Daryl Fairweather, the chief economist at Redfin. “If anything, the housing market has been overly sensitive to what the Fed has done with interest rates, both when interest rates were low and now when the interest rates are high.”
From the time the Fed indicated in December 2021 that it would be raising short-term interest rates to tamp down inflation – which had reached four-decade highs – it prompted a steady rise in mortgage rates.
Between the Fed announcement in December and its approval of a one-quarter percentage-point hike on Wednesday, mortgage rates for a 30-year fixed loan rose to almost 4% in early March from 3.3%.
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Homebuyers flooded the housing market in the first quarter of the year as they tried to beat the expected mortgage rate hikes – resulting in one of the most competitive quarters since the onset of the pandemic.
After reaching a record all-time high of $413,800 in June, home prices began declining on a month-over-month basis, before recovering slightly in February.
“Prices would not have fallen if the Federal Reserve did not raise interest rates so aggressively,” says National Association of Realtors’ Chief Economist Lawrence Yun. “One casualty of the Fed’s policy, aside from the regional banks, is the loss in home values for some homeowners.”
If the Fed had done nothing, where would home prices have been today?
While experts agree that the Fed’s monetary policy slowed down the price growth last year, there are varied opinions on what would have happened if they had done nothing at all.
“I don’t think the affordability actually would’ve changed, but it would have like been ripe for a bubble. If interest rates stayed low for too long, then a bubble would’ve formed in the housing market where once interest rates went up, it would’ve been a much harsher fall.”
House prices were on a tear in 2020 and 2021 because of the demand-supply imbalance in the housing market, says PNC Senior Economist Abbey Omodunbi.
“We have seen a significant slowing in housing activity since the Fed started tightening monetary policy last year. House price growth would have accelerated if the Fed didn’t start tightening monetary policy.”
While it is true that the Fed’s rate hikes, which led to higher mortgage rates, slowed price growth, it’s not clear what the counterfactual would have been, according to Bright MLS Chief Economist Lisa Sturtevant.
“The goal of the rate hikes was to reduce inflation. Unchecked inflation would have also seriously eroded buyers’ purchasing power, so the fast pace of price growth could have slowed anyway,” she says.
Jeff Taylor, founder and managing director at Mphasis Digital Risk and board member at the Mortgage Bankers Association, agrees with that assessment.
If the Fed had done nothing and inflation continued to run rampant, prices still would have come down most likely due to a much faster recession and economic hardship, he says.
“When it comes to median prices of existing homes, it’s most relevant for home buyers to look at price trends versus the previous month and relative to the pandemic peak. February existing home prices of $363,000 were up $4,000 from January, but down $50,800 from the pandemic era peak of $413,800 in June 2022,” he says.
Should the Federal Reserve raise rates again? What effect will it have on home prices if they do or don’t?
The Federal Reserve is between a rock and a hard place with the upcoming decision on whether to raise the short-term rate, says Sturtevant.
“My sense is they should pause rate hikes this month for two reasons: one, the uncertainty in the financial sector that has been at least partially brought on by rapid rate increases, and two, because of the way the data on housing costs are collected, falling rents and owner-occupied costs have not yet impacted the CPI, but they will in the coming months.
If the Fed raises interest rates, expect a more subdued spring housing market than originally anticipated at the beginning of the year, she says.
“If the Fed does not raise rates, that could signal their concern about the financial sector and economic stability, more generally, which could push mortgage rates lower and provide a burst of energy to the spring market,” she says.
Fed hikes cause lots of headline noise, but mortgage rates are lower than they have been for quite some time, more than 1% from their 7.375% peak on October 20, 2022, says Taylor.
“It is the daily trading of mortgage bonds – not Fed actions – that move mortgage rates,” says Taylor. “As bond investors get bullish seeing the Fed do its job to moderate inflation, mortgage rates will drop as lower future inflation makes bonds more valuable.”
And that is actually good news for homeowners, and as the Fed progresses on its inflation fight, mortgage rates are likely to drop more, he says.
“Prices dipped from the peak as higher rates resulting from the Fed inflation fight slowed home sales,” he says. “Prices rose slightly in February as rates dipped to near 6% in January.”
Swapna Venugopal Ramaswamy is a housing and economy correspondent for USA TODAY. You can follow her on Twitter @SwapnaVenugopal and sign up for our Daily Money newsletter here.