The Fed’s inflation fight has hit the housing market. Here’s what buyers need to know

The fate of the housing boom is on the minds of both homeowners and homebuyers these days. Will record home values lead to a crash reminiscent of the one that made the Great Recession so painful? Or will prices simply take a breather from their torrid pace of appreciation?

No one knows — not even the world’s most powerful central banker. Fed Chairman Jerome Powell has acknowledged a sharp rise in mortgage rates. They’ve gone from 3% in August to 6% now, according to Bankrate’s national survey of lenders.

“We’re well aware that mortgage rates have moved up a lot, and you’re seeing a changing housing market,” Powell said last week. “We’re watching it to see what will happen. How much will it really affect residential investment? Not really sure. How much will it affect housing prices? Not really sure. We’re watching that quite carefully.”

What it means for home prices

Housing economists don’t expect sharp drops in prices, at least not nationally. After all, supplies of homes for sale remain near record lows. And while a jump in mortgage rates has dampened demand somewhat, demand still outpaces supply, thanks to a combination of little new construction and strong household formation by large numbers of millennials.

The National Association of Realtors said Tuesday that rising mortgage rates have slowed home sales. Even so, the median price of homes sold nationally hit a record $407,600 in May, up 14.8% from May 2021, and the inventory of homes for sale remains below the levels of one year ago.

“It’s still a very tight market,” Powell said during last week’s remarks to reporters. “Prices may keep going up for a while, even in a world where rates are up. It’s a complicated situation.”

Powell: Buyers need ‘reset’

The sharp rise in home prices over the past two years has made affordability a major challenge, particularly for first-time buyers. Unlike repeat buyers, first-time buyers haven’t built an equity cushion as prices have soared.

“I would say if you’re a homebuyer, or a young person looking to buy a home, you need a bit of a reset,” Powell said.

While the Fed doesn’t directly control mortgage rates, it does set the federal funds rate, a number that reflects both economic reality and attempts to guide economic activity toward sustainable levels of growth. The Fed slashed rates to zero at the start of the coronavirus pandemic.

“Rates were very, very low for quite a while because of the pandemic, and the need to do everything we could to support the economy when unemployment was 14% and the true unemployment rate was well higher than that,” Powell said.

But as inflation has accelerated to 40-year highs, the Fed has responded by raising rates three times in 2022 — including a 0.75 percentage point increase last week.

What you can do

How homebuyers can cope with the still-challenging market:

— Shop around for a mortgage. Rates and fees vary significantly from one lender to the next. Comparing at least three offers from competing lenders can save you thousands of dollars over the life of the mortgage.

— Look for a low down-payment loan. For borrowers struggling to afford a home, the monthly payment is just one hurdle. Another is coming up with a down payment. With the typical U.S. home selling for about $400,000, coming up with 10% down means writing a check for $40,000. There is a potential workaround, though, in the form of mortgages backed by the Federal Housing Administration and the U.S. Department of Veterans Affairs. Both FHA loans and VA loans impose less onerous restrictions than conventional loans. While the standard down payment is 20%, VA loans require nothing down, and FHA loans have a minimum of 3.5% down.

— Consider a fixer-upper. For buyers frustrated by the lack of inventory and rocketing prices, older homes can be a good compromise. In Bankrate’s survey earlier this year, 21% of respondents said they would try this tactic. Of course, buying a fixer-upper means you’re taking on a project, one that brings uncertainty. No matter how careful you are about estimating your renovation budget, you can count on surprises — especially when materials costs are volatile and construction labor is in short supply. Renovation experts say you should anticipate cost overruns in the range of 15% to 20% of your construction budget.

— Move to a more affordable area. Many buyers are facing the harsh reality that they can’t afford to buy in the neighborhood they really want. In some cases, buyers are deciding to move out of the most challenging markets. Home prices have been soaring everywhere, but prices are especially eye-popping in California. The median price of an existing home sold in the Seattle area during the first quarter of 2022 was $746,200, according to the National Association of Realtors. However, a number of major metro areas boast home prices that are still affordable. They include Buffalo (median sale price of $202,300 in the first quarter), Philadelphia ($297,900), Louisville ($235,400), St. Louis ($216,700), Kansas City ($287,400) and Milwaukee ($298,800).