With mortgage interest rates nearly double what they were a year ago, according to Freddie Mac, home prices cooling and the threat of a recession, the 2023 mortgage market has a very unsettled outlook.

To understand the expected outlook for the mortgage market in 2023, it’s good to review what happened last year.

Year in Review

At the start of 2022, mortgage rates were at historic lows, ranging around 3.5% for a 30-year fixed mortgage. But as the Federal Reserve increased interest rates in an effort to stem inflation, interest rates for the 10-year Treasury and other interest rate-based financial instruments followed suit. By the end of the year, mortgage interest rates had more than doubled from where they were 12 months earlier.

The increasing mortgage rates led to a resulting slowdown in home sales and home equity refinancing, according to the Mortgage Bankers Association.

The trend started to reverse in late November as the Federal Reserve indicated that it would be slowing the rate of interest rate increases. Just as mortgage interest rates increased in connection with the Federal Reserve’s interest rate increases in 2022, mortgage interest rates started to decline as the Federal Reserve eased its upward interest rate actions.

Down Trend to Start 2023

Mortgage rates continued to drop in the first month of 2023, a trend that most economists expect to continue throughout the year. Freddie Mac said that the average rate for a 30-year fixed mortgage averaged 6.33% as of January 12, down from 6.48% a week earlier. That compares, however, to a 3.45% rate a year earlier.

The average rate for a 15-year fixed mortgage averaged 5.52% as of January 12, according to Freddie Mac’s Primary Mortgage Market Survey (PMMS). That was down from 5.73% a week earlier. A year earlier, the rate for a 15-year fixed mortgage averaged 2.82%.

Most economists expect rates to continue their downward trend, but how far rates will drop depends on a few different factors that each have uncertainties of their own. Inflation, the general direction of the economy, the cost of originating loans and other economic factors can all affect the direction of mortgage rates. So even if the general trend is down, there can be temporary blips when rates go up temporarily.

“While mortgage rates have resumed their decline, the [mortgage] market remains hypersensitive to rate movements, with purchase demand facing large swings relative to small changes in rates,” said Sam Khater, Freddie Mac chief economist, discussing the PMMS. “Over the last few weeks, latent demand has been on display, with buyers jumping in and out of the market as rates move.”

“After being overwhelmed in the housing frenzy of the recent past, homeowners, sellers, buyers and renters may be underwhelmed in 2023,” Realtor.com said in its 2023 housing forecast. It should be noted that Realtor.com is an outlier when it comes to interest rate expectations, with a forecast of 7.4% for the current year.

On the other side of the spectrum is Greg McBride, Bankrate chief financial analyst, who said in a blog that he expects 30-year mortgage rates to drop to 5.25% by the end of 2023.

“I think we could be surprised at how much mortgage rates pull back this year,” McBride said.

The Mortgage Bankers Association also expect rates to drop – and, like BankRate, predicts a steeper drop than Fannie Mae or Freddie Mae. The Mortgage Bankers Association December 2022 Finance Forecast anticipates that the 30-year fixed mortgages to be at 5.2% by the end of the year. But even that rate will be well above the sub-3% rates during 2021.

“You might have some weeks or some months where things might buck the trend,” said Joel Kan, MBA’s vice president and chief economist, in a U.S. News & World Report interview. “You might see a month or two where rates might come up because something happens in the market. The baseline is one thing, but there’s always room for some surprises.”

“2023 is not going to be nearly as eventful as 2022,” McBride added. “We should see a notable pullback in mortgage rates as inflation pressures ease and as the economy slows.”

With mortgage rates expected to decline during the year, the housing market, which had slowed greatly while interest rates were rising, should see a rebound, the first signs of which are already emerging.

Good Start to the Year

Mortgage applications increased 27.9% between the first and second weeks of January, according to data from the MBA’s Weekly Mortgage Applications Survey. The MBA’s Refinance Index increased 34% from the first week in January.

“Mortgage application activity rebounded strongly in the first full week of January, with both refinance and purchase activity increasing by double-digit percentages compared to last week, which included the New Year’s holiday observance,” said Mike Fratantoni, chief economist said in a press release. “Despite these gains, refinance activity remains more than 80% below last year’s pace and purchase volume remains 35% below year-ago levels.”

Fratantoni added: “Mortgage rates are now at their lowest level since September 2022, and about a percentage point below the peak mortgage rate last fall. As we enter the beginning of the spring buying season, lower mortgage rates and more homes on the market will help affordability for first-time homebuyers.”