Now that inflation is waning, there is hope that mortgage rates will fall to 5% in 2024. These lower rates would make borrowing to buy a home less expensive, but they could make the housing market much harsher for first-time homebuyers. That’s because a drop in mortgage rates would cause an increase in demand, and more demand without more supply is a recipe for competition. Like in 2021, we could see a spike in bidding wars, with the typical home selling above its asking price in record time. First-time buyers should prepare for a challenging road ahead as inflation dies down.

Inflation has held the housing market back

Inflation primarily affects homebuyers through mortgage rates. When mortgage rates increase, buyers must make higher monthly mortgage payments to afford the same-priced home. Inflation alone can increase mortgage rates. And the Fed’s tools against inflation also impact mortgage rates.

When the economy is on a path toward higher inflation, lenders must raise mortgage rates, or else the loans they make will become less valuable. For instance, suppose a borrower has a fixed-rate mortgage with monthly payments of $1,000 each month. If inflation is 5%, $1,000 a year from now is worth only $950 in today’s dollars. However, if inflation is 2%, $1,000 a year from now is worth $980 in today’s dollars. Therefore, the lender is more willing to lend when inflation is low.

Another way that inflation affects mortgage rates is through the actions of the Federal Reserve. As the Federal Reserve raises the Federal Funds rate in its fight against inflation, lenders must raise mortgage rates to offset their increased borrowing costs.

During the pandemic, mortgage rates fell to record lows. Homebuyers and homeowners were able to lock in 3% fixed-rate mortgages. Now that mortgage rates are close to 7%, homebuyers have backed off of the market, and so have home sellers. That’s because if homeowners sell, they aren’t just handing over their home; they abandon their rock-bottom mortgage rate. Newly built homes have added slightly to the number of homes for sale. Still, there are nearly 40% fewer homes for sale now than there were pre-pandemic.

More competition is coming

Assuming inflation wanes, and the economy remains in good shape. Mortgage rates could decrease from 7% to around 5% in 2024. In that scenario, many prospective homebuyers will return to the market. But unfortunately, that won’t be enough to motivate most homeowners to sell. A homeowner who is looking to move into a home that is the same price or more expensive than their current home will have to spend hundreds of dollars more per month on a mortgage and pay up to 6% of their home’s value in real estate fees.

Expensive markets like San Francisco and Seattle will have more homeowners willing to sell. Those home sellers can use their equity to confidently compete with cash on a lesser-priced home in a more affordable place. Consequently, competition will increase the most in hot migration destinations like Phoenix and Tampa, where homes are still relatively inexpensive.

Cash will still be king

As the number of homebuyers grows without an increase in sellers, competition in the housing market will intensify. As sellers regain the upper hand, they will increasingly reject bids with low down payments in favor of buyers with cash. FHA loans, meant for low- to moderate-income borrowers and popular with first-time homebuyers, have lower down-payment and credit-score requirements than conventional loans. The share of buyers using FHA loans is at its highest level since before the pandemic. That’s because right now most home sellers feel lucky to receive any offer at all, including offers from FHA borrowers. However, that could quickly change when low mortgage rates bring more buyers to the market.

When competition picks up, sellers will prefer buyers flush with cash who waive the home inspection and financing contingencies. Homes won’t necessarily sell for higher prices right away. However, it will likely become more difficult for first-time buyers to compete. Just like in 2021, it would become the norm for homes to sell in record time, with multiple bids, for tens of thousands of dollars above the asking price.

Buy now or later?

Homebuyers should brace themselves for the changing dynamics in the housing market. Today’s housing market isn’t easy, but at least sellers are willing to make concessions and accept low down payment offers. In the future, buyers will have to move quickly and make aggressive bids to be successful. Although mortgage rates will likely be lower in the future, it may be prudent for first-time homebuyers to purchase now before competition intensifies. Because homeowners can refinance their mortgages at a later date, buying now and taking advantage of low mortgage rates later may be the best strategy.