The Case for Sub-5% Mortgage Rates by 2023

While mortgage rates have a good chance of getting worse before they get better, hope might be on the horizon.

The long and the short of it is that mortgage rates go up as inflation goes up, which explains some of the recent increase.

The other driver was the end of the Fed’s mortgage-backed securities (MBS) purchase program, known as Quantitative Easing (QE).

As inflation began to surge, and the Fed dropped out as a buyer of MBS, mortgage rates skyrocketed from below 3% to around 7% today.

However, if and when inflation falls back to more typical levels, mortgage rates could quickly follow suit.

A Sub-5% 30-Year Fixed in the Next Six Months?

While it appears to be a very bold prediction, Barry Habib recently said “we think there’s a high probability that mortgage rates come back below five percent within the next six months.”

His interview on Mauldin Economics was posted on October 14th, meaning mortgage rates could be back in the high 4% range by mid-April.

It sounds crazy, given the current trajectory. After all, NAR chief economist Lawrence Yun just said mortgage rates could test 8.5% next.

And they’re currently over 7% for a standard, vanilla loan scenario, so to think they could drop back to below 5% in short order sounds like a long shot.

But Habib eats, breathes, and sleeps mortgage rates and is the brains behind MBS Highway, which provides in-depth market insights on a daily basis.

So if one person were to have a good guess as to the direction of mortgage rates, it might be him.

He even added that there’s “maybe an outside chance” rates hit those levels by the end of this year, which sounds even more ridiculous.

But again, the man is using logic. And he has received the Zillow and Pulsenomics Crystal Ball Award for the most accurate real estate forecaster on several occasions.

What Would Cause Mortgage Rates to Drop?

Unlike the Fed, which continues to battle inflation head on, and sometimes in the rear-view mirror, Habib is looking bigger picture. That is, beyond just the next month.

He seems to already see hope on the inflation front with monthly readings expected to drift lower. Perhaps inflation is already peaking.

And that lagging indicator is mostly all baked into the 7-8% mortgage rates you’re seeing today.

So once we start getting the favorable reports, and inflation does indeed fall, mortgage rates should follow.

Most financial analysts already expect the Fed to stop raising its fed funds rate by the end of this year or early next year, so we are getting to the latter stages of interest rate increases.

Once they stop raising rates, or even before that, mortgage lenders can take cues and mortgage rates can drop.

Simply put, Habib is looking ahead of these last couple Fed rate hikes of 2022, instead of worrying about what everyone knows and expects will transpire.

Last week, Mark Zandi, who recently called a housing correction, shared similar sentiment, saying he expects inflation to be cut in half in six months.

That supports Habib’s thesis. The other issue, though, is the end of the Fed’s MBS buying program, and now runoff of those securities. Could that flood the market and drive prices down (and interest rates higher)?

Fear not. Habib points out that with much lower mortgage origination volume, due to these higher mortgage rates, that shouldn’t pose much of a problem.

In other words, the Fed is no longer a buyer, but there’s also a lot less to buy out there, so it doesn’t create the shock we may have expected.

What Would Sub-5% Mortgage Rates Do to the Housing Market?

There’s a lot of doom and gloom out there at the moment when it comes to the housing market, home prices, the mortgage industry, etc.

But most pundits still qualify these negative statements with, “well, the housing supply is still low,” and “we don’t have the toxic mortgages this time.”

And even if home prices come down a lot, they’re still above 2019 levels. Oh, and homeowners are sitting on a ton of equity.

So there’s a lot negativity, but a lot of qualifiers too, unlike in 2008 when it was all just plain bad.

Sure, home prices got ahead of themselves, and the Fed’s current action is working to cool demand and bring prices down.

Once they’re done raising rates, we could see a more balanced housing market, with buyers and sellers on more or less equal footing.

Throw in sub-5% mortgage rates and you’ve got some normalcy again. And by normalcy, I mean more home sales, whether it’s move-up buyers or first-time home buyers.

Existing homeowners won’t be dealing with mortgage rate lock-in because they can stomach a move from a 3.5% rate to a 4.75% rate.

And first-time buyers will be able to afford a home again with both a cheaper interest rate and a lower asking price.

This is the ideal scenario. Some pullback in home prices to more reasonable levels, coupled with more balanced mortgage rates. Not 3% again, but something more average.

Whether this all happens remains to be seen, but the thesis makes sense on paper. And it would certainly be a blessing for the real estate and mortgage industry.