What the heck is going on with the housing market?

• The housing market is still surprisingly tight despite mortgage rates at 20-year highs.
• Demand is high and supply is low as current owners don't want to part ways with low rates they locked in years ago.

What the heck is going on in the housing market?

Prices have stayed stubbornly high even with mortgage rates near a two-decade peak, and mismatched supply-and-demand dynamics have sent conflicting signals about what comes next.

Conventional wisdom suggests that as rates rise, prices will fall. But that hasn't transpired, even after 10 rate hikes from the Federal Reserve, which have influenced the rate on all kinds loan products to march higher, including mortgages.

If experts can agree on one thing as it relates to housing, it's that the market has stayed surprisingly tight.

The explanation boils down to a unique set of circumstances that have unfolded in a distorted post-COVID world. A wave of people locked themselves into ultra-low mortgage rates, creating an inventory shortage. That's kept prices from falling, even as demand gets slammed by higher mortgage rates.

"The housing market is weird right now," LendingTree's senior economist Jacob Channel told Insider. "Relative to where we were during the pandemic, prices will probably stay high for some time compared to recent history."

Current homeowners are locked in

Higher rates aren't just deterring new buyers — they're also scaring sellers from putting their homes on the market. Even if a seller is able to offload at a lofty price, they still have to navigate the tight market as they seek their new home. For many people, leaving a sub-3% mortgage behind and inking one around 7% is a non-starter, even if they get a big windfall from a sale.

This population makes up a significant portion of homeowners. Nearly one-quarter are sitting on a mortgage rate of less than 3%, close to the highest amount on record.

"A 3% difference on a mortgage is gargantuan," Channel said. "You'd have to buy a house worth tens of thousands of dollars less to pay the same monthly rate. We have a convoluted market where there's not a lot of demand and people aren't actively looking to sell, but prices are still up."

Typically, when demand drops, supply goes up and housing becomes more affordable. But that's not what's happened over the last year. The average seller today can still attract about three offers for a listed home, according to data from the NAR.

Nadia Evangelou, a senior economist at the National Association of Realtors, confirms there are still more buyers than available homes. Middle-income house hunters — who should make up the largest share of the market — have been hit particularly hard this year, she explained. It all comes back to inventory.

"Earners of about $75,000 should be able to buy about half of all listings, but currently they can only buy about 23% of them," Evangelou said. "Especially for those looking for affordable homes, homebuyers are facing a double-whammy of high rates and low supply, which means prices have to go higher."

A surprise increase in new-home sales

Perhaps the most surprising development in the housing market has come in the form of recent increases in new-home sales and housing starts. Both are encouraging signs that homebuyer activity is headed for a rebound.

While existing home sales are down, sales of newly constructed homes jumped 20% year-over-year in May. When it comes to new construction, it's possible for homebuilders to offer buydowns that lower the overall mortgage rate for a buyers, according to Ali Wolf, chief economist for real estate firm Zonda.

As for housing starts, the resilience there offers a positive sign that construction is accelerating, having overcome years of difficult supply-chain issues following the pandemic. This is crucial because it could alleviate the inventory shortage and, by extension, help balance out the affordability equation for buyers. Theoretically home prices will fall or at least stabilize as inventory is replenished.

"I think there's been such a huge discussion about the lock-in-effect in the housing market and how homeowners don't want to get rid of their low interest rates," Wolf said. However, if they want to move and can get a builder to buy their rate down, all of a sudden that "hurdle goes away," she said.

What comes next

To Channel, there isn't a magic number that interest rates would have to fall to in order for demand to recover to previous levels. While mortgage rates aren't that high on a historical basis, the market is distorted in terms of supply and demand.

Channel says it's possible that demand could recover sharply if mortgage rates were to fall to around 5%, but that could also spur another jump in home prices as buyers rush back into the market. Lower rates could also unlock more inventory as homeowners come off the sidelines.

"On one hand, more demand puts upward pressure on home prices," he said. "But housing supply has decreased significantly, and that's also because it's become more costly to build and harder to get materials. But now supply chains are better and raw materials are decreasing in price. So we have two possible forces — demand could come back as rates decline, and supply could improve as building comes back."

Evangelou expects mortgage rates to stay above 6% through the end of the year before falling to about 5.6% in 2024. She expects home prices next year will rebound after cooling in the interim, coinciding with declining rates.

"We do need more homes on the market," she said. Evangelou expects the supply shortage to continue well into next year as low inventory fuels competition among homebuyers.

There's no immediate solution to inventory snags, as a home shortage would take many years to address, and there won't be anything like a 2008-style crash in home prices.

"People should just buckle in and expect the market to remain tough in terms of affordability," Channel said.