July 11, 2025
New and existing home sales plunged in 2022. We all know why. Home prices surged because of the shortage of building materials in the wake of the 2020 recession. At the same time the Fed began to raise the funds rate in an effort to bring inflation back under control. Housing affordability plunged and sales have been struggling since. What will it take to entice current homeowners to put their homes on the market? What will cause builders to ramp up the pace of production? The answer to those questions seems to be some combination of income growth, reduced prices and lower mortgage rates. But demographics may also play a role. For several years household formation far exceeded the growth in housing starts. In other words, demand far exceeded the supply. But household formation has now begun to slow and, for the first time in several years, the supply of new housing appears to exceed demand. That should contribute to lower prices in the months ahead and help to re-invigorate the housing market.in
Prior to the recession the housing market was on fire. Existing home sales were at a record pace of 6,600 thousand. New home sales were at a steamy pace of 950 thousand.
Houses were extremely affordable. A median income earning family at that time had 70% more income than required to purchase a median-priced home.
But then the world changed. First, house prices began to surge. In the wake of the 2020 recession supply shortages of building materials boosted builders’ cost of production which were then passed along to buyers. Home prices climbed at a 20% pace for the next two years. Inflation surged but the Fed initially believed the increase was going to be temporary. Thus, it opted not to tighten and waited for the inflation rate to abate. That did not happen.
The Fed finally recognized that inflation was not going to retreat and began to tighten in mid-2022. It eventually raised the funds rate from near 0% to 5.25% by the summer of 2023.
Higher short-term rates and rising inflation boosted mortgage rates from about 3.0% to 7.0%.
The combination of the dramatic increase in home prices and the doubling of mortgage rates caused housing affordability to plummet (see the chart above). A median income earning family which two years earlier had 70% more income than required to purchase a median-priced home, by mid-2022 had barely enough income to purchase that home. Home sales plunged and have been limping along for the past three years.
What is going to make that change? Housing affordability is determined by three factors — consumer income, home prices, and mortgage rates. All three should boost affordability in the months ahead.
Income growth reflects the combination of growth in employment and wages. Payroll employment has slowed, but is still climbing by about 135 thousand per month. And wages are climbing steadily at about a 4.0% rate. As a result, real disposable income, which is what consumers have after paying taxes and adjusting for inflation, has been rising by 1.7%. We expect that to continue for the foreseeable future. Thus, income growth should make housing somewhat more affordable between now and yearend.
Home prices have begun to edge lower. The Case Shiller Index of home prices has risen 2.7% in the past year, but prices have actually declined slightly in the past couple of months (see above). The bidding wars have disappeared. Builders are offering incentives to buyers in the form of reduced mortgage rates for the first year. Sellers of existing homes are finding they have to accept a slightly lower price to close the deal. All of this suggests that home prices should continue to decline slowly in the months ahead which will also boost affordability.
Mortgage rates will, amongst other things, reflect changes in Fed policy between now and yearend. Some economists believe the Fed will lower the funds rate twice by a total of 0.5% between now and December. We are not expecting that to happen and envision a steady funds rate between now and then. But even without Fed rate cuts, mortgage rates relative to inflation have risen sharply in the past couple of years and now stand at 4.0%. Historically, mortgage rates average about 2.2% higher than the inflation rate. Thus mortgage rates could decline somewhat in the months ahead even if the Fed does not ease. For what it is worth, we expect them to decline from 6.7% currently to 6.5% by yearend. Not a lot, but it should help to boost housing affordability.
Putting these three factors together suggests that housing affordability should increase from a situation today where an average income family has just enough income to afford a median-priced home, to a world where that same family might have about 10% more income than required by December. As affordability increases home sales should quicken.
In addition to the above, consider the following. For several years household formation far exceeded housing starts. In other words, housing demand far exceeded supply and, as a result, there is an existing shortage of housing of 1-5 million units. But beginning late last year the pace of household formation has begun to slow and now, for the first time in several years, housing starts exceed the number of households being formed. This slowdown in household formation is partially attributable to slower growth in immigration, as well as a reduced number of households lost each year caused by aging and mortality. Given reduced demand, home prices may get at least a slight downward nudge.
For the most part economists expect a slower pace of GDP growth between now and the end of this year, a higher rate of inflation caused by tariffs, and a 50-basis point cut in the funds rate. We are slightly more optimistic with respect to GDP growth with 2.4% growth expected in the final two quarters of the year. With inflation remaining steady at a rate about 0.7% higher than its 2.0% targeted rate of inflation, we expect no Fed rate cuts. Our more optimistic GDP outlook is fueled, in part, by a moderate rebound in the housing sector.
Stephen Slifer
NumberNomics
Charleston, S.C.
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