Homebuyers face record down payments as Fed backs off on rate cuts

Down payments are one of the biggest hurdles to homeownership, and they’re growing at an alarmingly high rate, especially for lower-tiered homes.

As of year-end 2023, the average down payment in the U.S. housing market was 16% of the sale price, or $84,000, representing an 8% spike year-over-year, according to CoreLogic. That’s the highest on record, underscoring the growing affordability challenges facing new buyers.

While the trend was apparent across all pricing tiers, it was especially stark for lower-tier homes, where buyers arguably need the most relief.

According to CoreLogic, down payment amounts on low-tiered homes, or those priced below 75% of the median sale price, neared $30,000 in December. That’s nearly 13% of the sale price as of December.

It wasn’t quite as high as middle-tier and high-tier homes where the average down payment percentages were a loftier 14% and 21%, respectively. Still, bottom-tiered homes experience the largest year-over-year increase in average down payments.

Down payment sizes are a reflection of home valuations, which have similarly been on an upward trajectory since the pandemic.

According to the St. Louis Fed, the average home price in Q1 2020 was $329,000, compared with $417,700 as of year-end 2023, representing a roughly 27% increase. It’s no wonder the homeownership rate across the nation has dipped from 68.1% in early 2020 to 65.7% as of Q4 2023.

Meanwhile, mortgage rates continue to hover near 7% while monthly mortgage payments march higher.

As a result, the trend of rapidly declining homebuyer affordability conditions spilled over into Q1 2024, as noted by Mortgage Bankers Association associate vice president of housing economics Edward Seiler.

“Challenging affordability conditions and low housing supply are keeping some prospective homebuyers on the sidelines this spring. The eventual, expected decline in rates in the coming months will hopefully spur new activity in the housing market,” he said.

While homebuyers and home-sellers await change, the Fed appears to be in no hurry to cooperate by lowering interest rates.

Economic uncertainty and the Fed

The Fed has all but promised a trio of rate cuts this year, sending off a bevy of ambitious forecasts from economists. But with half a dozen more meetings on the docket this year, sand is quickly escaping the hourglass on this one.

After the central bank decided to hold off on cutting rates in March, one Fed watcher has come out swinging. Canaccord Genuity chief market strategist Tony Dwyer told CNBC the Fed has no choice but to act in the face of a weakening labor market and easing inflation.

“I’m not saying that they have to go back to zero, but they have to be more aggressive. One of the most aggressive topics that I talk to clients about is how bad the incoming data is,” he said.

But he may have spoken too soon. The economy is also flashing signals of growth, as evidenced by the latest manufacturing data. The U.S. manufacturing sector expanded last month, interrupting 16 straight months of contraction in a sign of strength for the economy.

If the markets are any indication, investors are betting on interest rates remaining on hold until at least the second half of the year.

Gregory Faranello of AmeriVet Securities said that the latest data “feeds into the narrative coming out of last week” emboldening policymakers “to be patient,” resulting in interest rates that remain “higher for longer.”

The real impact of mortgage rates

There’s a reason why down payments are growing. Average mortgage payments reached a fresh all-time high last month, meaning that a bigger down payment is needed to qualify for a loan.

With an average home price of nearly $375,000, a homebuyer who takes out a 30-year fixed mortgage at a 6.87% interest rate would expect to pay $2,721 per month as of March. If that amount sounds alarmingly high, it’s because it’s up 10% versus year-ago levels, according to online real estate firm Redfin.

Meanwhile, the mortgage payment for homeowners looking to upgrade to a house valued 25% more than their current property would more than double, according to a report by the Intercontinental Exchange, which noted that it’s “hardly an entertaining proposition.”

As a result, the real estate market is experiencing what ICE described as the lock-in effect, where homeowners who were able to secure low rates during the pandemic era feel stuck in those properties today. Buyers who want to break from this mold will be on the hook for much higher payments.

With housing inventory constrained across metros, at 40% below pre-pandemic levels, the Fed remains be the key to unlocking more real estate deals, according to Andy Walden, vice president of enterprise research strategy at ICE.

“Mortgage rates need to come down to dislodge the lock-in effect,” he said.