Mortgage rates hovering around 8% coupled with home prices that rose substantially during the pandemic have deteriorated housing affordability in the U.S. and frozen activity in some cases. The longer mortgage rates remain elevated, the higher borrowing costs become, and that could tip the housing market into a recession, according to Wells Fargo. 

“After generally improving in the first half of 2023, the residential sector now appears to be contracting alongside the recent move higher in mortgage rates,” Wells Fargo economists wrote in a recently released commentary, titled simply, “Rising Borrowing Costs Stand to Tip the Housing Sector Back Into Recession.” 

For the first time in more than two decades, the 30-year fixed mortgage rate reached 8% in early October. And although rates may decline as the Federal Reserve eases up on its fight against inflation, financing costs will likely remain elevated compared to pandemic lows for the foreseeable future, according to the bank, which reported that prospects for a “housing rebound” are dimming as mortgage rates rise.

Although Wells Fargo did not cite the last housing downturn specifically, Charlie Dougherty, a senior economist at Wells Fargo, and Patrick Barley, an economic analyst at the firm, wrote of the similarities between the current housing climate and the 1980s. They echoed recent research from Bank of America Research and First American, as Fortune reported. For its part, BofA warned of “turbulence” coming that will resemble the 1980s, marked by high mortgage rates as Paul Volcker’s Federal Reserve fought to bring down double-digit inflation. First American suggested that housing had a case of 1980s déjà vu, with high inflation, high interest rates, and homebuyers coming of age—millennials turning into their boomer parents, essentially.

Mortgage rates to move lower, but remain elevated

“A ‘higher for longer’ interest rate environment would likely not only weigh on demand, but could also constrain supply by reducing new construction and discouraging prospective sellers carrying low mortgage rates from listing their homes for sale,” Dougherty and Barley wrote. 

Rising borrowing costs are set to further erode affordability, the economists wrote, citing a calculation by the National Association of Realtors (NAR) showing the average principal and interest payment for borrowers using a 30-year fixed rate mortgage was up 26% in August compared to a year prior. 

“The increase in monthly payments has far exceeded growth in median family income, which was up 5% over the same period,” Wells Fargo noted. And mortgage rates are up from August, which means even higher monthly payments now.

But it’s not just elevated borrowing costs that have deteriorated affordability—it’s also that home prices have risen over 40% since the onset of the pandemic, including each month so far this year, according to a calculation by CoreLogic, an information, analytics, and data-enabled services provider. Then there’s tightened supply, which, as the Wells Fargo economists noted, is partly due to homeowners holding on to their homes in fear of losing their low mortgage rates in an already under-built market. 

Still, assuming Wells Fargo’s forecast that the Fed has finished hiking interest rates and will lower them next year is accurate, mortgage rates should also move lower, Dougherty and Barley wrote. The average 30-year fixed mortgage rate would finish off this year at 6.94%, according to Wells Fargo’s national housing outlook. Next year, the bank forecasts the average 30-year fixed mortgage rate will be 6.39%—and in 2025, it’ll sink lower still, to 5.70%. 

The bank expects worsened affordability in the near term as mortgage rates remain elevated, which will in turn weaken housing activity. Home prices will continue to appreciate at a slightly slower pace because of underlying demand and tight supply, rising 1.8% by the end of this year, as tracked by Case-Shiller, and 2.5% in 2024. In 2025, Wells Fargo forecasts home prices will rise 4.4%.

The so-called lock-in effect has partly pushed existing-home sales to their lowest level in 13 years. But the decline in existing-home sales isn’t exactly surprising, Wells Fargo economists wrote, because housing is “one of the most interest-rate sensitive parts of the economy.” 

That’s why the NAR sent a letter to the Fed earlier this month, urging the institution to stop raising interest rates. The letter, the economists said, is reminiscent of the 1980s when homebuilders sent a piece of lumber to the Fed, asking for help in restoring housing demand via lower interest rates. Wells Fargo expects the pace of existing home sales to rise modestly next year.

“​In September, the count of existing single-family homes available for sale was 1 million, which equates to just 3.4 months of supply at the current sales pace,” the economists wrote, stressing that there is an underlying demand for homes that is keeping prices up, particularly as millennials are in their prime homebuying years. Still, there are signs supply is starting to rise, Wells Fargo economists wrote.

Meanwhile, the new-home sector “appears to be taking the hits from higher rates better in stride,” given new-home sales are up, which can largely be explained by builders offering incentives such as mortgage rate buydowns to attract buyers. Though the success might not last, Wells Fargo expects new-home sales to rise 4% next year.