Will a Recession Cause Home Prices to Plunge? Not Necessarily

Homeowners don't necessarily need to panic.

There's a reason so many would-be buyers have struggled to buy a home over the past year or two. Since the latter part of 2020, housing inventory has been sluggish, and that's led to a disconnect between buyer demand and real estate supply. And any time you have a situation where demand exceeds supply to a large degree, prices tend to skyrocket.

In fact, it's fair to say that 2022 has been an exceptionally challenging year for prospective home buyers not just because of sky-high home prices, but also, because of climbing mortgage rates. At this point, even strong borrowers are looking at paying twice as much interest on a mortgage than they may have been looking at this time last year.

Meanwhile, there's been a lot of talk of the U.S. economy entering a recession at some point in 2023. A big reason is that economists anticipate a major pullback in consumer spending as the Federal Reserve continues to aggressively raise interest rates, making borrowing prohibitively expensive.

If a recession were to hit in 2023, it could result in widespread unemployment and even more pain for stock market investors (many of whom are already beyond frustrated with their portfolios' performance this year). But will a recession batter the housing market? It may not.

Why home prices won't necessarily plummet

If a recession hits next year, it's fair to assume that it might impact home prices. We just talked about the relationship between supply and demand in the context of the housing market. When there's not enough of the former and too much of the latter, prices are apt to rise.

If the economy takes a turn for the worse, it could push more potential buyers out of the market. That could, in turn, narrow the gap between housing supply and buyer demand, thereby leading to a drop in home prices. But that doesn't mean homeowners should anticipate a dramatic drop in home values.

Right now, property values are really elevated, so much so that homeowners are still sitting on extraordinary levels of equity. Even if prices drop in 2023, that won't necessarily create a scenario where homeowners are suddenly underwater on their mortgages (which occurs when the value of a given home isn't high enough to cover its remaining loan balance).

Think about it this way. Imagine a given home's "normal" value is $350,000. Right now, that home may be worth $420,000. If a recession drives the value of that home down to $370,000 next year, it's a decline from $420,000 -- but it's not necessarily a decline from that home's baseline value.

Homeowners don't need to panic

Property owners who are managing their mortgages just fine shouldn't lose sleep over the impact a recession might have on housing prices. But those struggling to keep up with their home loan payments may want to consider getting out now -- before economic conditions worsen.

Similarly, those contemplating selling should get moving sooner rather than later. Between rising mortgage rates and a potential economic downturn, waiting to list a home means risking getting less money for it. Those who are in a position to sell their homes before the end of the year may want to consider going that route so they can command top dollar.