Home Affordability Still Under Pressure

0:00James Egan:Jim, why did the cranberry turn red?

0:06James Egan:Please enlighten me. Because it's all the turkey dressing.

0:14James Egan:I hope everybody had a good Thanksgiving. Welcome to Thoughts on the Market. I'm Jay Bacow, Co-Head of Securitized Products Research at Morgan Stanley.

0:22Jay Bacow:And I'm Jim Egan, the other Co-Head of Securitized Products Research at Morgan Stanley. Today, we're here to talk about our views for mortgage rates in 2026 and how that flows through to our U.S. housing outlook. It's Monday, December 1st at 1130 a.m. in New York. Now, Jay, as we all get over our turkey-induced naps over the weekend, how are we thinking about mortgage rates evolving in 2026?

0:49James Egan:Well, as you and I discussed previously on this podcast, the Fed cutting rates in and of itself doesn't actually cause the 30-year fixed rate mortgage to come down. However, our rate strategist forecast for lower rates in the front end should be helpful to where the primary rate ends up this year. And we would also expect some compression between primary mortgage rates and treasury rates given our bullish outlook for the mortgage asset class. So our expectation is that the third-year fixed rate ends 2026 around 5.75%. All right.

1:24Jay Bacow:If we get to 5.75%, maybe a little bit lower than that in the middle of next year, that's enough to send affordability into a healthier place. But that's a relative term. Affordability is still going to be under pressure, but it will have improved. And it will have improved at a pretty healthy amount from where we were in the fourth quarter of 2023, which was multi-decade levels of challenge. All right, Jim.

1:51James Egan:So clearly the mortgage rate coming down does make homes more affordable. But is it enough to cause more homes to actually transact?

2:01Jay Bacow:So the answer is yes, but it's going to be a yes, but answer from that perspective. We do think the transaction volumes are going to increase. But to put into context where we sit from a housing market perspective, we already saw a healthy increase in affordability from the fourth quarter of 23 through the end of 2024, right? But if we put that affordability improvement in context, we've seen that about 10 times over the past 40 years. The only times where sales responded more tepidly than they just did in 2025, or in 2009, the teeth of the great financial crisis, and in 2020 when the market really slowed down in the immediate aftermath of COVID.

2:39Jay Bacow:The lock-in effect is still playing a very big role. We do think that this sustained marginal improvement in affordability will help purchase volumes, but this is not what's going to get us to kind of escape velocity. We're calling for about a 3 % growth in purchase volumes next year.

2:55James Egan:All right. Now, you mentioned this a little bit already, but if there's less lock-in because the mortgage rate has come down, will more people be willing to list their homes for sale? Are we going to get more inventory on the market?

3:07Jay Bacow:I think that's the other piece of how we're thinking about housing moving forward. Any improvement we get in affordability from lower mortgage rates is going to be paired with increasing inventory volumes. We've already seen that. Listed inventories are up roughly 30 % from historic lows in 2023. They're still 20 % below where they were in 2019, so we're not talking about oversupply at this point. But that increase in listed inventories without a contemporaneous increase in demand is weighed on the pace of home price growth. We started this year at plus 4 % nationally. We're below plus 1.5%. We think that any growth in demand will come coincident with the growth in listing volumes that's going to keep home price appreciation under control.

3:49Jay Bacow:We're only calling for 2 % growth in HPA next year, 3 % out in 2027. But the high level thought here is that the housing market is well supported at these levels. Difficult to see big decreases in sales volumes or prices next year. but also going to be difficult to really achieve any more material growth than this low single digits we're calling for. But Jay, as you and I are talking about this outlook with market participants, one question that gets brought up frequently is what else can the administration do, especially on the affordability side, to help with instigating more housing activity?

4:29James Egan:In order to really help affordability, given the challenges that you've discussed around the supply and demand issues, then the other aspect of that is just what is the mortgage rate? And if they were to do things that would cause the mortgage rate to come down, that would be helpful. Now, the Fed already has made an announcement that they're going to continue mortgage runoff from their balance sheet. If they ended mortgage runoff, that would have helped, but that window seems to have passed. There's been some discussion from the administration around new types of programs. In particular, there was a lot of headlines around a 50-year program.

5:04James Egan:A 50-year amortization schedule would likely result in a material drop in the monthly payment that the homeowner would make, which would help. However, the total interest payments for that homeowner, depending on exactly where this hypothetical 50-year mortgage rate would price, are probably about double over the life of the loan relative to a 30-year fixed rate mortgage. So we're not really sure that this product would see a huge amount of upkeep. There's also some technical challenges around whether it meets the definition of a qualified mortgage and some other in the weeds discussions.

5:44Jay Bacow:What about all the discussion we're hearing around assumability of mortgages, portability of mortgages? Is there anything there?

5:51James Egan:Based on our understanding of contract law, which I have to confess is limited as I am not a lawyer, we don't think you can retroactively make mortgages portable or assumable that were not already portable or assumable. So you can make new mortgages portable and assumable. Portable, as a reminder, means that if you have a mortgage, you take it with you to your new house. And assumable means that the mortgage stays with the house. If you sell to somebody else, they get that mortgage. But realistically, we think this would have to be a new product. And because it would be a new product with new benefits to the homeowner, it would actually probably cause their mortgage

6:28Jay Bacow:rate to be higher, not lower. I guess one last question. We're talking about affordability, and we're addressing it through interest rates being lower. We're addressing it through the potential for new products to be put out there, even if there are some challenges around that piece of it. But what about just demand for mortgages themselves? You said the Fed might not be a buyer going forward, but are there other pockets of demand for mortgages that could help bring down mortgage rates?

6:56James Egan:Sure. So we expect the GSEs to grow their portfolio next year. That would certainly be helpful on the margin. We expect them to buy about a little less than a third of the net issuance that comes to the market. We also think that domestic banks could come back to the market and they could help bring the mortgage rates lower. But these changes are going to help mortgage rates by in the context of maybe an eighth of a point to a quarter of a point at most. It's not a panacea, unfortunately.

7:27Jay Bacow:All right. So we expect a little bit of an improvement in mortgage rates, a little bit of affordability improvement next year. That should lead to growth in purchase volumes. And I think it will lead to a little bit of growth in home prices, but the housing market is well-supported range-bound here. Jim, pleasure talking to you.

7:45James Egan:And to all our regular listeners, thank you for adding thoughts on the market to your playlist.

7:49Jay Bacow:Let us know what you think wherever you get this podcast and share thoughts on the market with a friend or colleague today. And as my kids would say, go smash that subscribe button. The preceding content is informational only and based on information available when created. It is not an offer or solicitation, nor is it tax or legal advice. It does not consider your financial circumstances and objectives and may not be suitable for you. We hope everybody had a good Thanksgiving. And now we're here to talk about housing and mortgage markets.

8:23Jay Bacow:Are you recording? I feel like there's nothing wrong with that. What are you guys talking about? From like a kid's thing. All right.