Growing supply shortages are holding housing prices higher, and affordability constraints coupled with elevated rates lock potential sellers in place.

Home prices fell in January, pulling back by 0.24% from December to mark the smallest monthly decline in seven months, according to Black Knight‘s mortgage monitor report. The annual home price growth rate fell to 3.43% in January, more than a full percentage point below the 30-year average.

Price impacts could strengthen again if 30-year rates continue to climb, as they have through late February, although tight inventory will put a floor on how much prices will ease, the report noted.

Black Knight expects the annual home price growth rate to fall below 0% by March or April.

The three-pronged challenge of inventory shortages, unaffordable housing and rising interest rates kept home prices more moderate, as supply can’t match demand, the report said.

“Today, we see buyer demand dampened under pressure from rising rates and their impact on affordability, with purchase rate-lock volumes cooling in late February,” Andy Walden, vice president of enterprise research strategy at Black Knight, said in a statement.

As of the week ending Feb. 25, purchase lock counts were 21% below the same week in 2019, and 30% below the levels during the same week in 2018.

“We’ve seen a consistent theme of potential sellers – many with first-lien rates a full 3 percentage points below today’s offerings – pulling back from putting their homes on the market,” Walden said.

Months of supply stagnated at about 3.1 in recent months due to a combination of falling demand and a weakening inflow of new listings. About 25% fewer homes were listed for sale in January than normal, which is why inventory fell last month, despite home sales hitting more than a seven-year low.

With 30-year rates at 6.5% in late February, it took 33.2% of the median household income to make the monthly principal and interest payments on the average home purchase. That’s up from January’s 32.4% and significantly above the 30-year average of about 24%, but still 3.5 percentage points below the 37% level reached in October 2022 when affordability hit a more than 35-year low.

“Between escalating inventory challenges and worsening affordability, we’re seeing some volatility in the market – just not in the form of widespread, steep price corrections,” Walden said.

Data showed that half of all mortgaged homes have first-lien interest rates at or below 3.5%, a full three percentage points below today’s market rate, and two-thirds are at 4% or lower.

In 2022, about $2.4 trillion – consisting of $1.65 trillion in purchase mortgages and $731 billion in refinance – in first lien mortgages were originated in volume, down by about half from $4.3 trillion in 2021.

Both purchase and refinance lending are expected to reach their floor in the first quarter of 2023 before trending modestly higher through the year, Black Knight projected.

Rising interest rates are the predominant driver as such rate increases have made it more expensive to access home equity and have simultaneously incentivized borrowers to withdraw equity via second lien products instead.

“This makes intuitive sense as borrowers with higher balance loans, looking to extract small to moderate levels of equity, are intended to keep their low first lien interest rate and utilize a second mortgage or home equity line of credit (HELOC) at a higher interest rate to borrow against their equity,” the report said.

The national delinquency rate declined 10 basis points to 3.38% in January and is now down 15% year-over-year.

Mortgage delinquencies may be poised to push even lower through the end of the first quarter, Black Knight projected. February and March typically have strong seasonal downward pulls on delinquency rates, as borrowers use tax refunds to pay down past-due mortgage payments, the report explained.

“While serious delinquencies are down, the market is expected to face performance-related headwinds this year, and we’re already beginning to see it impact lower-income borrowers,” according to Black Knight.

The housing market faces a three-pronged challenge