Economic Strength vs. Housing Strain: iEmergent’s Mortgage Market Projections

At the end of March, the preliminary HMDA data for 2023 was released, and now, we at iEmergent have updated our mortgage origination forecast to align with that new information. For 2023, first lien mortgage originations totaled $1.44 trillion, a 37% decline from 2022 and the lowest level since 2014. Moreover, we expect this year will only be slightly better. Our forecast for 2024 is $1.59 trillion, with only a modest increase in purchase volume – mostly driven by loan size increases – and continued low levels of refinances.

The primary driving factors discussed in our previous forecast update blog remain in play. The strength of the overall American economy continues to surprise on the upside. That strength has resulted in a slower-than-expected decline in long-term interest rates which has hobbled both purchase and refinance origination prospects. In fact, recent months’ data on the strong labor market and disappointing news on disinflation resulted in rising short- and long-term interest rates in the first four months of the year before declines occurred in the latest month.

The major macroeconomic indicators still look generally positive, but chronic problems in the housing market will dampen the mortgage origination outlook:

• Inflation: The Fed’s preferred inflation indicator, the change in the core PCE price index (personal consumption expenditures price index excluding food and energy), has fallen steadily. In 17 of the 18 months since September 2022, the year-over-year change has declined, reaching 2.8% in March – not quite down to the Fed’s 2% target but moving in the right direction.
  
  
• Real GDP: Since its slight hiccup in early 2022, real GDP growth has been strong, with the latest year-over-year growth rate at a robust 3.0% in Q1/2024 – an unexpected and remarkable feat in the current tight monetary policy environment.
  
  
• Employment: The labor market also continues to be unexpectedly strong. With the rapid rise in interest rates, most economists had projected at least a percentage point rise in the unemployment rate last year. Despite that pessimism, it hardly moved and is still under 4%, not much higher than what it was before COVID hit (3.5%) – which was the lowest since the 1960s.
  
  
• Interest rates: On the short-term side, the Federal Reserve hasn’t raised the Fed Funds target rate since its last hike to 5.25-5.50% in July last year, but it is maintaining its tight monetary policy stance. While Fed Chair Powell said early in the year we were “not far” from where the Fed might begin cutting rates, it doesn’t appear now that that will happen until late summer at best. On the long-term side, the 10-year Treasury yield is bouncing around between 4.0-4.5%, while the 30-year fixed mortgage rate is bouncing around 7.0%.

However, the housing market is a challenge. On the one hand, rising home price pressure indicates housing demand remains strong. On the other hand, depressed home sales levels suggest weakening demand. Total home sales (existing home sales plus new single-family homes) were 4.767 million in 2023, 22% lower than the pre-pandemic 2019 level of over 6 million. Adjusting for the growth in the number of households in that time, current home sales are nearly 25% below that 2019 level.

It might seem like inconsistent signals, but it’s not. The housing market is severely depressed due to chronic inventory shortage, a constant condition over the last decade that’s only gotten worse in the last few years. Low supply creates rising pressure on prices. Prices have gotten high enough that they are unaffordable for many potential homebuyers, hence the depression in sales. Yet home prices will continue to have upward pressure because homebuyers remaining in the market must bid them up to compete for the meager supply of homes available for purchase.

Unaffordability has become particularly acute in the last two years because rising interest rates have raised the cost of mortgage payments. But even before that, another, more fundamental force was also driving unaffordability. Since the pandemic, home prices have risen much faster than household incomes. In our estimation, the gap between home prices and household income has reached a similar magnitude as the one that triggered the housing bust of 2007 and led to the Great Recession.

This doesn’t mean we expect another housing bust now. Conditions now are quite different than they were in 2007. Back then, the housing market was over-supplied. As sales fell, prices – and thus, all home values – also fell. When homeowners began going “underwater” on their mortgages, i.e., when the principal on their mortgages exceeded the value of their homes, many of them, particularly those with little to no equity in their homes, stopped making mortgage payments. This ultimately resulted in distressed sales and foreclosures, which further exacerbated the over supply, creating a vicious cycle further lowering home values. We don’t see this happening now, though we do see depressed sales levels until the home price / income gap narrows.

In our forecast assumptions, we now believe that there will NOT be a recession this year, but that the U.S. economic juggernaut will continue to roll on into 2025, though at a decelerating pace. This will result in a slower decline in long-term interest rates than many economists expect, even if the Fed begins to cut short-term rates this year. As a result of high interest rates and the home price / income gap, we expect home sales to continue at their current weak pace, eventually leading to softening home prices going into next year, though there’s some risk that sales levels may fall even lower. 

For 2024, we forecast a 9% increase in purchase dollar volume but only a 2.8% increase in loan counts, so most of the gain will be due to increases in average loan size. We expect refinances to rise to only 18% of mortgage originations, only slightly more than their record low of 17% in 2023. 

By 2025, we expect further deceleration in GDP growth and ultimately a mild decline. The resulting lower long-term interest rates and softening home prices should lead to slightly higher mortgage origination levels. Refinance volumes should increase significantly, albeit from historically low levels, but purchase volume growth may slow.