It's official: Higher mortgage rates are truly terrifying potential homebuyers

• Mortgage applications sank to a 26-year low in December, according to the Mortgage Bankers Association.
• Applications for refinancing also fell, dropping by 87% compared to the same period from 2021.
• Higher mortgage rates have weakened demand and affordability for many American households.

After a year of rapid home price growth and surging mortgage rates, fewer Americans were interested in purchasing homes in December — so much so that mortgage demand fell to a 26-year low.

Mortgage applications decreased 13.2% for the week ending on December 30, 2022, marking the lowest reading since 1996, the Mortgage Bankers Association indicated in a Wednesday report. The decline demonstrates just how damaging higher housing costs have been for the US real estate market. 

"Purchase applications have been impacted by slowing home sales in both the new and existing segments of the market,"Joel Kan, MBA vice president and deputy chief economist, said in the report. "Even as home-price growth slows in many parts of the country, elevated mortgage rates continue to put a strain on affordability and are keeping prospective homebuyers out of the market."

Higher mortgage rates are also responsible for lower refinance volumes. The refinance index — a measure of  applications to refinance an existing mortgage — declined 16.3% and was an astounding 87% lower than the same week in 2021. According to Kan, mortgage rates would have to "decline substantially" to generate additional activity.

In a stark contrast to the homebuying bonanza of 2021, housing demand fell sharply in the fall and winter of 2022. Steeper housing costs, as well as surging inflation that kept the cost of living elevated throughout the United States, weakened affordability for many would-be buyers. This led to a substantial pullback in new and existing home sales, as well as housing construction. It's a predicament that could cool down the housing market further in 2023 — especially if mortgage rates remain above 6%. 

Although mortgage rates were on a downward trajectory throughout December — offering many cash-strapped buyers some much needed relief — they have already begun to reverse course in January. The average US fixed rate for a 30-year mortgage rose to 6.48% this week, according to a Thursday report from Freddie Mac. That's significantly higher than the pandemic low of 2.68% seen in December 2020, and means Americans still have a long way to go before rates come back down to earth. 

There's a glimmer of hope: Inflationary pressures, which have partially been responsible for the surge in mortgage rates, are finally beginning to ease. 

The latest inflation report shows that data came in cooler than expected in November. The lower inflation falls, the more likely the Federal Reserve will be convinced that their rate-hike strategy in combatting inflation is working. This could lead to the Fed slowing its pace of interest rate hikes, which may in turn result in a drop for the 10-year Treasury bond price and ultimately mortgage rates as the average rate on a 30-year mortgage closely correlates with long-term Treasury yields. 

The lower rates fall, the more likely Americans are to return to the US housing market.

"Homebuyers are waiting for rates to decrease more significantly, and when they do, a strong job market and a large demographic tailwind of Millennial renters will provide support to the purchase market," Khater said. "Moreover, if rates continue to decline, borrowers who purchased in the last year will have opportunities to refinance into lower rates."