The Fed’s rate cuts could have unintended consequences for the housing market

Over the past couple of years, the US economy has wrung out inflation like dirty mop water from just about every sector — except for the housing market, which remains paralyzed by high prices and chronically low supply.

But the action that could help solve America’s home affordability crisis could potentially make it worse. To understand why, let’s take a look at how we got here.

At the core of the housing puzzle is a supply and demand imbalance. It’s Econ 101: There are more people ready to buy than there are houses for sale. That was true even before the pandemic came along and sent demand through the roof. The market had become all but impenetrable after mortgage rates went from historic lows in 2020 to their highest levels in a generation last year.

When the Federal Reserve (almost certainly) starts to cut rates Wednesday, it should, in theory, shake the market loose.

But a lot depends on how aggressively the central bank moves to bring borrowing costs down across the board.

A half-point rate cut — which seems unlikely, but is not out of the question — would send a signal to the market that the Fed is serious about reversing the “lock-in” effect that makes homeowners with low-rate mortgages reluctant to sell in a high interest-rate environment.

If the Fed reverses course as aggressively as it raised rates, financing costs would go down, creating a flood of inventory of existing homes and taking some heat off prices.

“As counterintuitive as it sounds, in this post-pandemic cycle this would be an unmitigated good,” Daniel Alpert, managing partner of Westwood Capital tells me. Lowering owner-occupied housing costs also pulls people out of the rental market, and that in turn lowers rents — what Alpert calls a “Goldilocks scenario.”

A for sale sign is displayed outside of a home for sale on August 16, 2024 in Los Angeles, California. United States real estate industry rules governing agent commissions will change on August 17 as part of a legal settlement between the National Association of Realtors and home sellers. (Photo by Patrick T. Fallon / AFP) (Photo by PATRICK T. FALLON/AFP via Getty Images)

Related article Here’s what you should know about buying a home ahead of a likely interest rate cut

But a slower, more gradual easing might not do much to jolt owners, especially those who secured those early-pandemic-era, less-than-3% mortgages, to move. That’s especially true when American home prices remain at a record high.

That’s part of the supply problem.

The Fed can’t build houses, but it can — by indirectly influencing mortgage rates with its benchmark rate — make the prospect of selling more appealing for homeowners. Already, market anticipation of a rate cut at the September Fed meeting has brought mortgage rates down to 6.2% last week, from 6.7% at the beginning of August.

“If the Fed takes a more dovish turn, I think we could get down to around 6%,” Daryl Fairweather, chief economist at Redfin, tells me. “And I think if we even go down to 5.9%, that would be really psychologically impactful to the housing market. I don’t think it’s going to get us all the way back to pre-pandemic existing inventory. But it could get a lot of people off the fence.”

Potential homebuyers — and folks who bought a home in the last couple years — meanwhile, are clamoring for any relief they can get. The current 6.2% mortgage rate average is, of course, preferable to last year’s peak of 7.8% — a difference that could translate to hundreds of dollars in monthly payments.

All of that brings us to potential unintended consequences of the Fed’s actions this week, and for the next several months. By solving the demand side of the equation without fixing the supply issue, the Fed may end up exacerbating the home affordability problem it is aiming to solve.

As my colleague Samantha Delouya wrote this week, a drop in mortgage rates could be a double-edged sword.

“It’s one of those things where you should be careful what you wish for,” said Greg McBride, chief financial analyst at Bankrate. “A further drop in mortgage rates could bring a surge of demand that makes it tougher to actually buy a house.”