Mortgage Demand Is Down: What Home Buyers Need to Know

It wasn’t long ago that it was much easier to sell a house. The proof is in the demand for mortgages, which recently fell to a new 28-year-low. Within one week in early March 2023, new mortgage applications declined by 6%, shriveling to levels we haven’t seen in decades. For that to happen in only one week suggests mortgage demand may be falling faster than consumers can keep up.

Mortgage demand may be down for several reasons, but experts pinpoint three factors as the most prevalent. What do home buyers need to know to navigate this new economic environment?

Recent data continues year-long mortgage trend

Money experts typically assess mortgage demand based on one variable: the number of mortgage applications being filed. If there’s no demand for mortgages, we would expect new mortgage applications to hit new lows; that’s exactly what we’re seeing now.

Data from the Mortgage Banker Association’s seasonally-adjusted index shows mortgage applications dropped 6% in one week in the spring of 2023. But it’s not just the week-over-week changes home buyers should note. The volume of mortgage applications was a full 44% lower than in the same week in 2022. That puts mortgage applications at a 28-year low.

Higher interest rates have upended the market. While mortgage borrowers could expect interest rates as low as 4.17% in March 2022 (one year ago), they now regularly see them in the 6-7% range, if not higher.

However, the rate of applications has been on a downhill slide since January 2022, suggesting it’s not all about interest rate policy. High prices may have precipitated a drawdown in new mortgage applications before the rampant inflation of 2022.

Fewer mortgage applications are another market indicator that housing demand is low and real estate could be cooling off.

All these factors indicate a potential decline in sales activity for the housing market throughout 2023.

Four factors are dropping mortgage demand

As with so much in the economy, there may not be one specific factor driving mortgage demand downward.

Tighter lending practices

For starters, lenders are tightening their lending standards as mortgages become more expensive. In February 2023, one Federal reserve loan officer survey backed up tightening standards being a contributing factor in declining mortgage rates. Borrowers simply can’t meet the standards lenders have for their programs, whether it’s in required down payment or debt-to-income ratio. This, in turn, is leading to lower mortgage application rates.

Why are banks tightening their standards? If it’s harder for the average American to afford a mortgage, it means that banks have to be more judicious with the mortgages in which they invest their money to lower their risk of a bad investment. They can’t simply issue any mortgage they like; they have to know that home buyers can pay their debt obligations.

Phenomenal price growth

Add to that how home prices have continued their year-over-year appreciation. With some markets reporting double-digit sales price growth year-over-year, home buyers are being priced out–before they even think about applying for a mortgage.

On the heels of that is mortgage affordability. With higher interest rates, it becomes more difficult for the average investor to afford a mortgage. Mortgages become more expensive both on a per-month basis and for the duration of the loan. A $240,000 loan on a 30-year fixed rate of 5.118% interest pays almost $300 less a month than the same loan at a 7.118% interest rate.

Higher inflation rates

It all hinges upon higher inflation, which caused the Federal Reserve to raise interest rates. Combine the rising home prices with high inflation, and home borrowing is becoming less affordable for the average American.

Higher inflation has led the Federal Reserve to raise interest rates in an effort to quell this inflation. You might hear the phrase “tighten” referring to higher interest rates. And that’s what it does, tightening the flow of money and discouraging debt. When mortgages are more expensive to acquire, banks tighten lending standards, home buyers’ wallets, and economic conditions. And that’s exactly what we’re seeing in the housing market right now.

What a Decline in Mortgage Demand Means for Home Buyers

It trickles down through the market. Fewer interested buyers makes it harder for people to sell their homes. That forces them to reduce their list price or offer other incentives that reduce the value gained from their home sale.

And these economic factors are encouraging homeowners to stay in place. As the Washington Post notes, the “3% mortgage just keeps getting better.” In other words, having a fixed-rate mortgage on a home at the lower rates we saw a few years ago incentivizes people not to sell in the current market.

It creates a market with fewer homes, fewer people looking to buy those homes, and a slower market.

The future outlook

What about the outlook for the future of mortgage demand? It may depend on the Federal Reserve and its policy on interest rates. With the banking crisis hitting Silicon Valley Bank and others in early 2023, there may be more pressure on the Federal Reserve not to raise interest rates. That could potentially cool off the tight restrictions contributing to the dip in mortgage demand, eventually restoring some balance to the system.

Mortgage demand being down might eventually lower home prices as owners try to generate more interest from buyers. Still, higher interest rates could keep mortgage prices high and deter potential buyers. That could make for stagnant home price growth and an environment where anyone with a 3% fixed-rate mortgage wants to stay put. We’ll have to monitor Federal Reserve interest rates policy as we enter the summer of 2023.