Mortgage Demand Plummets 41% Due to Rising Rates. But Will That Help Push Home Prices Downward?

Buyers are backing off -- but will that help the market cool off?

When mortgage rates began dropping to record lows during the second part of 2020, buyers began clamoring for homes, to the point where mortgage lenders were inundated with applications. But home loan demand has waned recently on the heels of higher mortgage rates.

Mortgage rates have been rising quickly since the start of the year. And as of this writing, the average 30-year mortgage isn't far off from 5%. For context, the average 30-year loan didn't even hit 4% at any point in 2021.

Not shockingly, rising mortgage rates have caused a steep decline in buyer demand. Last week, total mortgage application volume, which includes refinances, fell 6% compared to the week prior, reports the Mortgage Bankers Association. More notably, total mortgage demand was down 41% from the same week one year ago.

Now to be clear, refinance demand has dropped more so than purchase mortgage demand. And a decline in refinance activity is unlikely to have an impact on home prices. But if purchase mortgage volume starts to fall at a more rapid pace, that could influence home prices -- and create a scenario where buyers finally get some much-needed bargaining power.

Could home prices finally come down?

Home prices have been elevated since 2020, due largely to a glaring lack of inventory and a healthy level of buyer demand. Rising mortgage rates won't automatically influence the former -- we can't necessarily expect sellers to start listing their homes at a rapid clip because mortgage rates are on the rise (though some sellers might choose to list sooner rather than later due to climbing rates).

But rising rates could drive buyers away due to affordability issues. Once that happens, and demand lessens, home prices could start to drop.

That's imperative right now. Although home prices aren't necessarily higher today than they were at many points last year, the difference is that mortgage rates have gotten much more expensive. Many buyers can't swing both a higher purchase price and borrowing rate.

Buyers need relief

Today's housing market is an extremely challenging one for buyers to navigate. This especially applies to first-time buyers, who may have more limited financial resources and may not be in a position to dive headfirst into bidding wars.

If mortgage rates continue to rise, it could drive buyers to pull out of the market, leading to a dip in home prices. While we can't say with certainty that mortgage rates will keep climbing higher, that's a likely scenario.

The Federal Reserve has several rate hikes planned for 2022. The Fed doesn't set mortgage rates, but historically, an increase in the federal funds rate has resulted in higher mortgage rates. And there's no reason to think this year will be any different.

Those who have struggled to purchase a home in recent months may benefit from sitting tight for a bit to see if prices come down. While that does mean taking the risk of getting stuck with a higher mortgage rate, paying much less for a home could more than make up for that.