Despite countless calls for recession from economists, analysts and other experts this year and last, the U.S. economy as a whole has demonstrated remarkable resilience. On the housing market, however, things look different.

Mortgage rates of around 8% and home prices that have risen significantly during the pandemic have worsened housing affordability in the U.S. and, in some cases, frozen activity. The longer mortgage rates remain elevated, the higher the cost of borrowing will become, and that could tip the housing market into recession, according to Wells Fargo.

“After generally improving in the first half of 2023, the housing sector now appears to be shrinking along with the recent rise in mortgage rates,” Wells Fargo economists wrote in a recent commentary simply titled “Rising borrowing costs can “Tip.” The housing sector is returning to recession.”

For the first time in more than two decades, the interest rate on 30-year fixed-rate mortgages reached 8% in early October. And although interest rates may fall as the Federal Reserve eases its fight against inflation, funding costs are likely to remain elevated compared to pandemic lows for the foreseeable future, according to the bank, which reported that prospects for a “recovery in the The real estate market worsens when mortgage rates rise.

Although Wells Fargo did not specifically mention the recent housing downturn, Charlie Dougherty, a senior economist at Wells Fargo, and Patrick Barley, an economic analyst at the company, wrote about the similarities between the current housing climate and the 1980s. They reflected current research from Bank of America Research and First American Assets reported. BofA, for its part, warned of impending “turbulence” similar to that of the 1980s, which was marked by high mortgage rates as Paul Volcker’s Federal Reserve struggled to bring down double-digit inflation. First American suspected that there was a 1980s déjà vu in housing, with high inflation, high interest rates and the coming of age of homebuyers—millennials essentially morphing into their boomer parents.

Mortgage rates will fall but remain elevated

“A longer-term higher interest rate environment would likely not only weigh on demand, but could also constrain supply by reducing new construction and discouraging potential sellers with low mortgage rates from listing their homes for sale,” Dougherty and Barley wrote.

Rising borrowing costs would further hurt affordability, the economists wrote, pointing to a calculation by the National Association of Realtors (NAR) that shows the average principal and interest payment for borrowers taking out a 30-year fixed-rate mortgage in August increased by 26% a year ago.

“The increase in monthly payments far outpaced the growth in median family income, which increased 5% over the same period,” Wells Fargo noted. And mortgage rates have increased since August, which now means even higher monthly payments.

But it’s not just increased borrowing costs that have worsened affordability – it’s also that house prices have risen over 40% since the start of the pandemic, including every month so far this year, according to a calculation by CoreLogic, an information provider -, analysis and analytics company provider of data-driven services. Add to that tighter supply, which Wells Fargo economists noted is partly due to homeowners holding on to their homes for fear of losing their low mortgage rates in an already underdeveloped market.

However, assuming Wells Fargo’s forecast that the Fed has finished raising rates and will cut them next year is accurate, mortgage rates should also fall, Dougherty and Barley wrote. The average interest rate for 30-year fixed-rate mortgages would be 6.94% this year, according to Wells Fargo’s national housing outlook. Next year, the bank predicts the average 30-year fixed mortgage rate will be 6.39% – and in 2025 it will fall even further to 5.70%.

The bank expects affordability to deteriorate in the near term as mortgage rates remain high, which in turn will weaken property activity. Home prices will continue to rise somewhat more slowly due to underlying demand and tight supply, rising 1.8% by the end of this year and 2.5% in 2024, according to Case-Shiller. For 2025, Wells Fargo predicts real estate prices will rise 4.4%.

The so-called lock-in effect has pushed sales of existing homes to their lowest level in 13 years. But the decline in existing home sales isn’t exactly surprising, Wells Fargo economists wrote, as housing is “one of the most interest-rate sensitive parts of the economy.”

That’s why the NAR sent a letter to the Fed earlier this month asking the institution to stop raising interest rates. The letter, the economists said, was reminiscent of the 1980s, when homebuilders sent a piece of lumber to the Fed asking for help restoring housing demand through lower interest rates. Wells Fargo expects the pace of existing home sales to increase slightly next year.

“​In September, the number of single-family homes for sale was 1 million, representing just 3.4 months of supply at the current sales pace,” the economists wrote, emphasizing that there is an underlying demand for homes that is keeping prices high, especially as Millennials are in their home-buying prime. Still, there are signs that supply is starting to increase, Wells Fargo economists wrote.

Meanwhile, the new construction sector appears to be “better able to absorb the impact of higher interest rates” as new home sales have increased, largely explained by builders offering incentives such as mortgage rate buybacks to attract buyers. While the success may not last, Wells Fargo expects new home sales to rise 4% next year.

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