Mortgage rates are pulling back from 8%, a seemingly promising sign for sidelined buyers. But further declines could unleash pent-up demand.

“If rates fall below 7%, I think we’re going have a surprisingly strong year,” Daryl Fairweather, chief economist at Redfin, told Yahoo Finance Live (video above). “That’s when I think we’re going to see more people out there with bidding wars.”

The average 30-year home fixed-rate mortgage fell to 7.22% this week, according to Freddie Mac, and rates seem to be on course to drop further by the year-end. Overall, rates have scaled back more than a half-point in the last five weeks.

Read more: Mortgage rates at 20-year high: Is 2023 a good time to buy a house?

That’s prompted some buyers to get back in. The volume of mortgage applications for a purchase increased 5% for the week ending Nov. 24 versus the previous week, according to the Mortgage Bankers Association (MBA).

At the same time, the median monthly mortgage payment shrank over $100 during the last month as rates edged away from 8%.

That means a buyer purchasing a home at last week’s average rate of 7.29% would face a median monthly mortgage payment of $2,575. That’s down $164 from the all-time high of $2,739 set a month earlier, according to Redfin, but 13% higher than a year ago.

“Rates going up to nearly 8% has reset the threshold for buyers wanting to get back into the market,” Fairweather said.

Read more: How to buy a home in 2023

Still, purchase activity remains 20% lower than one year ago, MBA found.

“The purchase market remains depressed because of the ongoing, low supply of existing homes on the market,” Joel Kan, MBA’s deputy chief economist, said in a press statement.

However, there may be a glimmer of hope for those still on the hunt.

New listings posted their biggest year-over-year increase since 2021 during the four weeks leading up to Nov. 26, Redfin found.

Those purchasing may also benefit from new listings on the market, which have climbed 5.8% year-over-year, Redfin data found – the biggest uptick in over two years. Overall, the share of new listings amounted to 64,576. By comparison, new listings were falling at this time of the year, Redfin analysts noted.

“They’re going to be more people who are wanting to move because they have a new job or they’re getting married or they’re having kids, so people’s lives go on and that creates demand,” Fairweather said. “And if we have a strong stock market, people may feel good about spending money, but those high rates are the biggest drag on the housing market right now.”

Read more: How to get a 3% down mortgage in 2024

Prospective home buyers leave a property for sale during an Open House in a neighborhood in Clarksburg, Maryland on September 3, 2023. Homeownership feels increasingly out of reach for younger generations of Americans, who are squeezed by student debt and childcare costs in an era of slower economic growth. ( (Credit: Roberto Schmidt, AFP via Getty Images)

Prospective homebuyers leave a property for sale in a neighborhood in Clarksburg, Md., on Sept. 3. (Credit: Roberto Schmidt/AFP via Getty Images) (ROBERTO SCHMIDT via Getty Images)

‘Limited inventory will create bidding wars’

Though some homeowners have put their listings on the market, most are still reluctant to list.

Some 37% of homeowners believe it’s a bad time to sell a home, according to Fannie Mae’s latest housing sentiment index. Overall, 78% of respondents also said they thought the economy was on the wrong track in October, up 7 percentage points from the month prior.

The problem is that rates may fall enough next year to convince buyers to come back, but not enough to persuade enough homeowners to sell.

“If rates fall, we will see more buyers come back to the market and with limited inventory that will create bidding wars that push up prices,” Fairweather said. “We’re seeing a bit of relief on new listings right now with more sellers deciding now is the best time to sell and maybe that will continue into next year. So hopefully, we’ll have a bit of a balanced situation even if rates do decline.”

According to Redfin, available inventory of homes on the market amounted to 4.2 months of supply as of Nov. 26. At least 4 to 5 months is considered a balanced market, per Redfin.

Fairweather added: “But I don’t think that balance is going to last. The overall story for the housing market is that there are fewer homes available compared to the number of people who want to buy a home… The fact [rates] have come down a little bit makes me more optimistic, but I think it’s gonna be another slow year at least when we look back historically.”

Gabriella is a personal finance and housing reporter at Yahoo Finance. Follow her on Twitter @__gabriellacruz.

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