Will the housing market improve with inflation slowing?

It’s true: Pending sales were up 2.5% in December — the first increase since last May, and according to the Mortgage Bankers Association (MBA), there was a 7.4% increase in mortgage applications in the first week of February.

All of these signals are a lot to keep track of if you’re thinking about buying a home. Here’s what to watch for — and why it might make sense to focus your efforts on saving for a down payment during this volatile time.

Inflation’s role in mortgage rates & the housing market 

Inflation impacts the housing market in multiple ways. First, it makes the cost of building a home more expensive, as materials get pricier. These added costs lead to higher home prices, making it harder and costlier to buy a house.

Inflation also has a big hand in mortgage rates. When inflation is high, the Federal Reserve increases its benchmark rate — or the interest rate banks must pay to borrow money — to combat it. When banks pay more, they pass the excess costs onto customers, typically by way of higher interest rates on loans, credit cards, and mortgages.

“In response to inflation peaking in 2022, the Federal Reserve hiked overnight bank-to-bank lending rates eight times since the start of last year,” says Jeff Taylor, founder and managing director of mortgage services provider Mphasis Digital Risk. “This caused mortgage rates to spike [by] more than 3% in 2022.”

As interest rates rise, homes get even more expensive — and many buyers retreat from the market. This is why house prices (and home sales) slowed in the latter part of last year when mortgage rates surpassed 7%. It’s also why the housing market picked back up in recent weeks as mortgage rates began to drop and the Fed eased up on its rate hikes. (The Fed voted for a mere 25-basis-point increase in January vs. the 75-point ones seen a few months ago.) 

“The shift is all about mortgage rates,” says Joshua Massieh, CEO and mortgage broker at Pacwest Funding. “They went up so fast and to such a high level, it was hard for buyers to even keep up. When rates started falling back a bit, some of these prospective buyers perked up.”

Will mortgage rates go down? 

It appears the Fed’s attempts to tamp down inflation are working — though perhaps not as quickly as the bank had hoped. Inflation declined in January at a slower pace than many economists predicted — and prices climbed 0.4% on “core” goods and services (what’s left after stripping out volatile food and fuel prices), the same rate as in December. To some experts, the report’s mixed messages are a worrying signal that inflation may not be as locked down as previously thought. That could mean the Fed will continue hiking the benchmark interest rate further into 2023.

If the January report is just a blip, however, it could mean house prices begin to drop and mortgage rates fall — but that’s not necessarily guaranteed. 

“While a reduction in inflation can be beneficial for consumers with regard to their mortgages, other factors such as economic growth, employment, and consumer confidence also influence the trend of these markets,” Massieh says. 

Fortunately, most expert housing market predictions show mortgage rates holding steady or even declining as the year goes on. According to MBA, rates will likely hit 5.2% by year’s end. Fannie Mae, on the other hand, predicts a slightly higher 6.3% — roughly where mortgage rates were at the beginning of February. 

“Fannie Mae’s projections are following the Fed’s strong stance that, even if they slow or stop hikes of overnight bank-to-bank rates, that they’ll still keep these rates higher for longer to squash inflation,” Taylor says. “This is ultimately good for the inflation fight, the long-term resilience of the economy, and for homebuyers.”

How to prepare for your mortgage application

The flip side to all this uncertainty is that interest rates on savings accounts are on the rise, particularly on high-yield savings accounts offered by online banks. Rates on the best-yielding accounts are topping out above 4%, so it makes sense for some potential homebuyers to focus on saving for a down payment rather than trying to right-time mortgage rates. (In the end, a larger down payment typically means lower mortgage rates anyway). 

You should also work on your credit as you gear up to buy a home or refinance. Your credit score will play a role in both the loan programs you qualify for and your interest rate. 

Finally, determine your homebuying budget and weigh your loan options. You can use online tools for this part or get in touch with a loan officer or mortgage broker for more personalized guidance.

Keep in mind that your budget and loan options may change as mortgage rates fluctuate. As Massieh puts it, “​​Interest rates can be a major factor in the monthly payment of your mortgage, so it's important to keep up with updates and evaluate their effect on you.”

The bottom line

Some of the early-year optimism around inflation has begun to wane. The longer it takes to fully quell rising costs, the more potential there is for mortgage rates to increase. 

So what’s a homebuyer to do in the meantime? Continue watching mortgage rates, think about saving for a down payment instead, and, if you must move now, consider locking in your mortgage rate with a float-down option just in case mortgage rates drop again. 

Editorial Disclosure: All articles are prepared by editorial staff and contributors. Opinions expressed therein are solely those of the editorial team and have not been reviewed or approved by any advertiser. The information, including rates and fees, presented in this article is accurate as of the date of the publish. Check the lender’s website for the most current information.

This article was originally published on SFGate.com and reviewed by Lauren Williamson, who serves as Financial and Home Services Editor for the Hearst E-Commerce team. Email her at lauren.williamson@hearst.com.