Downside risk to home sales is limited despite 7% rates: Fannie Mae

The housing market faces renewed headwinds with mortgage rates settling above 7%. Still, the downside risk to home sales is limited as more sales are being driven by life events, according to Fannie Mae’s Economic and Strategic (ESR) Group.

“New home sales were surprisingly strong in the first half of the year, due partly to homebuilder rate buydowns, which become more expensive when mortgage rates rise,” Fannie Mae’s ESR group said in its latest commentary

As more sales are driven by life events and fewer are from discretionary move-up buyers, Fannie Mae sees limited further existing home sale downside.

Additionally, the mortgage application measure and the pending home sales index are increasingly diverging, reflecting the higher cash share of sales, the ESR group noted. 

While the additional downside risk from rate movements to date is minimal, the prospects of a recovery in existing sales in the near future is unlikely given strong mortgage rate “lock-in” effects and stressed affordability.

Going forward, the ESR Group expects new home sales to pull back slightly due to the higher mortgage rate environment and recent decline in homebuilder confidence.

Homebuilder confidence fell six points from July to a reading of 50 in August. It’s the first decline in 2023 reflecting the difficulties of 7% mortgage rates and reduced housing affordability. 

The recent rise in mortgage rates will also now test the resiliency of the new home sales market, which showed remarkable strength over the first half of the year.

The lack of existing homes for sale has helped support demand for new homes, including an increasing share of first-time buyers. 

To what extent homebuilders will continue to offer generous mortgage rate buydowns to drive sales is a big question that needs to be answered, according to the ESR group.

“When mortgage rates originally jumped to 7% in late 2022, a pullback in homebuilder activity ensued as buying activity slowed. It is uncertain whether this same rate threshold will result in a similar effect this time around or whether buyers and homebuilders have increased their willingness to purchase and subsidize at current rates,” Fannie Mae noted. 

Fannie Mae expects Q4 new home sales to average around 691,000 units on an annualized basis, down slightly from the most recent pace of 714,000 in July.

Purchase mortgage origination volume is expected to be $1.3 trillion in 2023 and $1.4 trillion in the following year. Refi volume is forecast to be at around $10 billion in 2023 and $14 billion in 2024.

Fannie Mae’s projection of a mild economic downturn in Q1 2024 remains unchanged. 

While the GSE’s initial April 2022 forecast of a mild recession was in the second half of 2023, housing production held up and household savings supported consumer spending longer than Fannie Mae had expected. 

“Our current prediction for a mild downturn in the first half of 2024 is predicated on the belief that consumers will begin pausing their spending, in part due to the exhaustion of those funds and having to realign to a more sustainable relationship between spending and incomes,” said Doug Duncan, SVP and chief economist at Fannie Mae.