Will the drop in interest rates shake the California real estate market?

The past two years have been brutal for many prospective homebuyers, as high home prices and mortgage rates created the most unaffordable housing market since the 2000s bubble.

While many experts do not expect drastic improvements to happen any time soon, change may finally be underway.

The cost of a 30-year fixed-rate mortgage has fallen from over 7% in May to just under 6% last week. On Wednesday, the Federal Reserve cut its benchmark interest rate for the first time since 2020. In an effort to combat inflation, it began raising rates in 2022.

“I think we’re going to live in a world over the next two years where the pressure on interest rates is easing,” said Daryl Fairweather, chief economist at real estate brokerage Redfin.

It is unclear how much mortgage interest rates will fall.

The cost of a mortgage is heavily influenced by inflation because institutional investors who buy 30-year mortgages in bulk do not want to see the value of their investment eroded.

Experts attribute the recent decline in mortgage rates to easing inflation, but also to expectations that the Fed could cut its key interest rate, as it did on Wednesday, because consumer prices are rising less sharply.

The Fed’s benchmark interest rate does not directly affect mortgage rates, but it can do so indirectly because it sets a floor for all borrowing costs and provides a signal about how anchored the Fed believes inflation is.

Keith Gumbinger, vice president of research firm HSH.com, said Wednesday’s Fed rate cut is unlikely to have a significant impact on mortgage rates because mortgage investors had, to some extent, already anticipated that rates would fall in response to the Fed’s decision.

However, even more cuts are to be expected in the future.

Gumbinger said if the Fed succeeds in achieving a so-called soft landing – that is, curbing inflation without triggering a recession – he would expect mortgage rates to be around 5% by this time next year.

If an economic crisis were to occur, mortgage rates could fall even further. But even in that scenario, Gumbinger doubts they would reach the range of 3% or less seen during the pandemic.

Orphe Divounguy, a senior economist at Zillow, predicted that rates would not even fall to 5.5%, but would remain roughly at current levels. He argued that the economy is relatively strong and inflation is unlikely to slow.

“I don’t think we’re going to see a big decline, but what we’ve seen so far has been great for homebuyers,” he said.

In fact, even small declines in borrowing costs can have a big impact on affordability.

If a buyer puts 20% down on an $800,000 home, the monthly principal and interest payments are $4,258 with a 7% mortgage, $3,837 with a 6% mortgage, and $3,436 with a 5% mortgage.

Whether falling interest rates will provide lasting relief is another question. Falling borrowing costs could attract a flood of additional buyers and drive up property prices – especially if increased demand is not met by increased supply.

Currently, the number of homes for sale is increasing slightly, interest rates are falling and house price growth is slowing.

In August, home prices across Southern California fell slightly from the previous month. While values ​​were still nearly 6 percent higher year over year, according to data from Zillow, that was less than the 12-month increase of 9.5 percent in April.

In theory, this combination of factors could provide a chance for potential buyers to enter the market. However, many do not seem to do so.

According to Redfin, 7.8% fewer homes were placed into escrow in the U.S. in the four weeks ending September 8 than in the previous year.

In Los Angeles County, sales increased 2% year-over-year, but were below early summer levels.

Fairweather says buyers may be holding back right now because they haven’t noticed the drop in interest rates or because they are temporarily deterred by recent changes to real estate agent commission rules.

Some agents say they are noticing an increase.

Costanza Genoese-Zerbi, a Redfin agent in the greater Los Angeles area, said she’s noticed more first-time buyers shopping lately, leading to an increase in multiple listings in entry-level neighborhoods where people are more price-conscious.

There is no major improvement for other agents.

South Bay and San Pedro real estate agent Jake Sullivan has a theory: Homes are still much more expensive than they were a few years ago.

The costs for building insurance have also increased.

“The cost of living is just so high,” Sullivan said.