Lower Interest Rates May Boost Home Renovation Spending

The longstanding nationwide housing shortage, low housing turnover, a drag from hurricanes, and the recent run-up in mortgage rates are expected to lower existing home sales in the coming months.

Mortgage rates remain high even after the Federal Reserve began cutting the fed funds rate in September, and will not necessarily decline more sharply as the Fed continues to lower rates. That's because current mortgage rates already reflect the bond market’s expectation of several rate cuts this year and the next.

Goldman Sachs Research anticipates the Fed to continue cutting 25 basis points at each of the next three FOMC meetings. Our strategists expect mortgage rates to remain elevated for the foreseeable future, potentially falling to 6.1% towards the end of 2025.

Goldman Sachs Research noted when housing markets are tight, a given decline in mortgage rates tends to stimulate a greater amount of home improvement activity. Since there aren’t many available options for new homes, homeowners are more likely to be motivated to invest in their current homes instead of moving.

The housing supply conundrum

Mortgage rates began falling sharply at the end of 2023 before rebounding in the first half of 2024 on the prospect of a later start to the Fed’s rate cutting cycle.

Since then, mortgage rates have declined on net and now stand around 6.5%, partly reflecting greater confidence in the inflation outlook and renewed expectations for the Fed to continue to lower rates.

The combination of mortgage borrowers refinancing at lower rates in 2020 and 2021, and the high current level of mortgage rates has created a significant financial cost to moving – buying a new home would require homebuyers to prepay their existing mortgage and take out a new mortgage at a significantly higher rate.

About 85% of homeowners with a mortgage have interest rates below current market rates, and almost 70% have rates more than two percentage points below market rates.

As a result, Goldman Sachs Research forecasts existing home sales to total just 4.1 million in 2025 – ending the year at a roughly 4.25 million pace – which is only modestly above the 2024 estimated total of 4 million.

Historically large home equity may spur home improvement projects

Revolving home equity loans tend to be more sensitive to the Fed’s rate cuts. According to Goldman Sachs Research, revolving home equity loan growth has picked up in recent months, suggesting that lower rates may already be incentivizing some households to tap into the historically large amount of home equity to fund their home improvement projects.

Home improvement spending grew at an annualized rate of 8% in the first half of 2024, propelled by growth of household real estate wealth, which has jumped from 105% of GDP at the end of 2019 to 135% today. The rapid accumulation of home equity over the last five years presents a tailwind for continued spending growth.

Even though mortgage rates have rebounded recently, our analysts expect the gradual decline in interest rates over the next year should provide more incentive for homeowners to tap into their mortgage equity.