Prospective homebuyers are painfully aware of just how bad the housing market is right now. Mortgage rates have doubled since 2022 following the Federal Reserve’s initiative to raise rates and curb inflation. Beyond pushing monthly payments up, consistently high mortgage rates have created a so-called lock-in effect, where existing homeowners are unwilling to sell their homes and give up the lower rates they secured earlier.
Higher monthly payments combined with a supply-constrained housing market make buying a home extremely difficult right now, but relief is looming on the horizon, according to one real estate expert.
Chen Zhao, the head of economic research at Redfin, believes that housing supply will start increasing by the end of 2025. In an interview with Business Insider, she shared her predictions for the housing market and mortgage rates.
Rates aren’t going to hit pandemic lows again…
Zhao has good and bad news for prospective homebuyers. First, the bad news: Gone are the days of 3% mortgage rates. Rates aren’t returning to pandemic lows again.
„Those were historically low rates,“ Zhao said. „Mortgage rates essentially just went down for 40 years, and they hit a trough with the pandemic.“ Barring a full-blown recession, Zhao believes it will be very difficult for mortgage rates to dip below the mid-five percent range. „With no recession, a longer-term neutral rate is basically around 5.5%,“ Zhao said.
If a recession does occur, it’s possible that the Fed could severely slash rates, but several Wall Street strategists are skeptical the US economy will reach that point.
As a result, homebuyers should get used to the reality that rates are going to settle at a higher baseline.
…but they’re going to start dropping soon
Now for the good news: Rates will come down, and they’ll drop faster than expected. This will boost housing supply and lead to increased activity in the real estate market by the end of 2025, according to Zhao.
It’s looking increasingly likely that the Fed will cut rates in September: „nearly 100% certain,“ according to Zhao. Currently, the federal funds rate is 5.33%, and Zhao believes that the Fed is aiming for a neutral rate of 3.5%. Additionally, Zhao believes that after the market pullback last week, the Fed will begin cutting rates faster than planned to avert a potential recession. Originally, Zhao estimated it could take up to two years to reach a 3.5% interest rate, but after the market’s recent volatility, she thinks rates could hit that level in the next 12 months.
As a result, mortgage rates will follow suit and decline as well.
„It’s very possible that mortgage rates will be in the lower sixes by the end of this year,“ Zhao said. „They could be hitting the high five or mid-fives towards the end of next year.“
Unlocking the housing market
Even though mortgage rates aren’t returning to pandemic lows, Zhao doesn’t think this will deter existing homeowners from selling their houses in the next year. She anticipates that a 5.5% mortgage rate will unlock a lot of current homeowners for two reasons.
First, existing homeowners will be incentivized to sell after the aggressive asset appreciation of the last few years. Home prices shot up over 40% during the pandemic and increased 6% in just the last year. According to Bank of America, home prices are expected to rise 4.5% by the end of 2024 and 5% in 2025. But as home price appreciation slows down in the future, current homeowners might see an opportunity to sell.
Even though homeowners who sell would still have to pay a higher mortgage rate than the one they’re currently paying, Zhao points out that homeowners who bought houses during the pandemic are currently sitting on a lot of home equity thanks to the price runup of the last few years. Once they sell, homeowners can use the home equity towards a down payment on a new house.
„That can help to alleviate some of the pain associated with getting a higher rate,“ Zhao said.
Second, people will move around. In Zhao’s view, people often don’t stay in the same location for long periods of time. Factors such as family, jobs, and other personal preferences can lead current homeowners to relocate. Increasing concerns about climate change will also drive migration as people move from high-risk areas to ones with less exposure to natural disasters, according to Zhao. Zhao points to Florida as one state that’ll be hit particularly hard by climate migration as insurance rates and HOA fees rise rapidly.
The housing market isn’t going to unlock overnight, but Zhao is optimistic that conditions will improve for homebuyers going forward.
„It’s going to be a combination of rates coming down a little bit to a level that feels more acceptable and also people feeling more necessitated to move,“ she said.