What Is a Recession and How Does It Affect Mortgages?

When the economy is in a recession, it affects your financial life in different ways. If you’re looking to buy a home, the uncertain economic climate can complicate the process. But there also can be advantages to buying a home during this time.

Here’s a look at what you need to know about recessions, and how they can affect your mortgage.

What Is a Recession?

A recession occurs when the economy contracts instead of expands. Usually, that means the country’s gross domestic product falls and unemployment rises. The National Bureau of Economic Research says a recession occurs when economic activity declines for more than a few months, and a recession ends when the economy resumes expansion.

Recent recessions

Recessions are a normal part of the economic cycle and vary in severity.

The COVID-19 pandemic drove the American economy into a recession in 2020. Closures and lockdowns hit the leisure and hospitality sector particularly hard, with almost half of the 17 million workers in that sector losing their jobs in the first two months of the pandemic. While housing prices dipped temporarily, they later increased significantly due to low interest rates and government stimulus funding.

The 2008 recession, also known as the Great Recession, was triggered by a collapse in home prices after they had doubled between 1998 and 2006. Borrowers had taken on increasing amounts of debts — including subprime mortgages — to afford to buy homes. When they began to default, the bubble burst and, from 2007 to 2009, the average sales price of a house fell more than 20%.

Are We in a Recession Right Now?

Inflation and rising mortgage rates have prompted fears of recession. However, as of the beginning of 2023, the United States is not in a recession. While GDP declined in the first two quarters of 2022, this downturn reversed by the end of the third quarter, which saw growth in GDP.

How Does a Recession Affect Mortgages?

So, you may be asking, What happens to mortgages during a recession? Do mortgage rates go down during a recession?

The good news is that recessions tend to result in a less competitive housing market and lower home prices. The bad news is that getting a mortgage can be more difficult because mortgage lenders will tighten eligibility requirements.

Home prices

Home prices tend to decrease during recessions, and how much they decrease depends on the causes of the recession and other market conditions. For example, falling home prices during the 2008 recession were more extreme than the temporary dip seen during the 2020 recession. While a decline in home values is bad news for homeowners, it can indicate a good time to buy.

Market supply and demand

During a recession, the supply of homes on the market tends to increase as there are fewer buyers who qualify for loan or decide to buy. At the same time, there will be more people who can’t afford their mortgage and decide to sell, which also increases supply.

Interest rates

During a recession, mortgage rates tend to decrease. To stimulate the economy, the Federal Reserve will adjust the target federal funds rate to drive down mortgage rates and encourage borrowing.

Another reason interest rates fall is because higher unemployment will result in less demand for mortgages.

Here’s a look at the average interest rate for a 30-year fixed-rate mortgage over the last 50 years. You’ll notice that mortgage rates typically decline during recessions.

Ability to borrow

Recessions can make it more difficult to borrow money to finance a home purchase. That’s because lenders know unemployment makes it harder for borrowers to keep up with their mortgages.

To reduce this risk, all types of mortgage lenders tend to tighten their qualification requirements. During a recession, you may need a higher credit score and make a larger down payment to qualify. In addition, you may be approved for a smaller home loan than you would during better economic conditions.

What To Do If You Can’t Pay Your Mortgage

What happens to loans during a recession? As long as you can continue to pay it off, nothing.

But if you get laid off during a recession and can’t keep up with your mortgage payments, you should contact your lender to discuss relief options. Depending on your circumstances, one of the following options may be the right fit for you:

• Refinance. If interest rates have dropped, you may benefit from refinancing to a lower rate to reduce your monthly payment, if qualified.
• Loan modification. Another option is to extend your loan term and make your monthly payment more affordable.
• Forbearance. With forbearance, your lender allows you to temporarily pause or reduce your monthly payment. However, you’ll still be on the hook for those payments later.
• Short sale. If you’re in danger of foreclosure, you can sell your home for less than what you owe on your mortgage. If your lender agrees to a short sale, you can use it to pay off your mortgage.

FAQ

Here are answers to some frequently asked questions about buying a home during a recession.

What happens to interest rates during a recession?

During a recession, the Federal Reserve may cut interest rates in an effort to stimulate the economy, which will result in mortgage rates going down. However, there are other factors that influence which direction the Fed will push interest rates. For example, the Fed increased interest rates seven times in 2022 to battle inflation.

What are the signs of a recession?

A recession is technically defined by a decline in GDP that lasts more than a few months. Here are some signs that the economy may be headed toward a recession or already be in one:
— Increase in unemployment.
— Decrease in consumer spending.
— Decline in manufacturing.
— Decline in retail markets.

Is a recession good for homebuyers?

A recession can be a good time to buy a home as it may coincide with low interest rates and lower home prices. However, recessions also come with higher unemployment and economic instability, which can prevent many prospective homebuyers from taking advantage of these conditions.