Since 2020, mortgage rates have taken homebuyers and homeowners on a wild ride. In the early part of the pandemic, the Federal Reserve slashed rates to zero, and 30-year mortgage rates plunged below 3 percent.

Then, in 2022, inflation raged, the Fed moved aggressively to cool the economy and mortgage rates surged past 7 percent.

Now, mortgage rates are taking a long-awaited breather. The average rate on a 30-year loan stood at 6.74 percent as of Dec. 28, according to Bankrate’s national survey of lenders.

Bankrate’s forecast for mortgage rates

Mortgage rates are likely to fall even farther in 2023, housing economists predict. Greg McBride, CFA, Bankrate chief financial analyst, expects 30-year mortgage rates to drop to 5.25 percent by the end of 2023.

I think we could be surprised at how much mortgage rates pull back this year.

— Greg McBrideCFA, Bankrate chief financial analyst

“2023 is not going to be nearly as eventful as 2022,” McBride says. “We should see a notable pullback in mortgage rates as inflation pressures ease and as the economy slows.”

How inflation could cause rates to dip

Soaring consumer prices have been the primary force driving mortgage rates in the past year. The COVID-19 pandemic spurred the Fed and the federal government to stimulate the economy. The Fed slashed interest rates and bought bonds, while Congress pumped out trillions in economic stimulus.

Those policies kept the U.S. economy out of a prolonged recession, but they also caused prices to soar. The U.S. inflation rate peaked at 9.1 percent in June 2022, according to the U.S. Labor Department.

With inflation out of control, the Fed had no choice but to aggressively raise rates. The central bank boosted interest rates by a quarter-point in March 2022, then by a half-point in May. The Fed raised rates even more in June, by three-quarters of a percentage point — which was, at the time, the largest Fed rate hike since 1994 — and went on to do the same in July, September and November. The Fed ended the year with a half-point bump in December.

The Fed’s strong stand did cool prices. Inflation slowed to 7.7 percent in October, then to 7.1 percent in November. That welcome trend seems to indicate that the Fed can back off, and that mortgage rates might dip, too.

“I think we could be surprised at how much mortgage rates pull back this year,” McBride says. “But we’re not going back to 3 percent anytime soon, because inflation is not going back to 2 percent anytime soon.”

Why the housing market will be tough on buyers

While the U.S. economy could fall into recession in 2023, McBride says, he doesn’t think home values will collapse. There is simply too much demand from buyers and too little supply from sellers.

“I don’t expect broad-based declines in home prices even though mortgage rates have doubled,” he says.

The prediction is a welcome one for homeowners, but it’s not so great for would-be buyers. Many Americans bought homes as prices soared in the past two years. Others remain shut out by the combination of still-high home prices and mortgage rates that are near their highest levels in decades. As a result, housing affordability has plunged.

The sharp rise in mortgage rates has cooled the housing market. Home sales have fallen for 10 consecutive months, the National Association of Realtors said in December.

However, mortgage rates could fall to the range of 5.5 percent by the spring and summer of 2023, says National Association of Realtors Chief Economist Lawrence Yun. “If that’s the case, I think the housing market will see some rebound,” Yun says.

Pay attention to the mortgage ‘spread’

Runaway inflation is just one reason mortgage rates rose so sharply in 2022. There’s another culprit, to​​o, one that’s apparent only to those familiar with the inner workings of the mortgage market: the gap between 30-year mortgage rates and their closest proxy, the 10-year Treasury yield.

This interval, known to economists as “the spread,” typically runs between 1.5 and 2 percentage points. If the 10-year yield were 2 percent, for example, the 30-year rate should track closer to 4 percent.

Consider the week of Jan. 19, 2022. Then, the average rate on a 30-year mortgage was 3.75 percent, according to Bankrate’s survey. The 10-year Treasury, meanwhile, was yielding 1.83 percent.

In other words, spreads were perfectly normal.

Now, as mortgage rates have increased, spreads have gotten wacky. By Nov. 9, the average 30-year rate in Bankrate’s survey was 7.08 percent, but the 10-year yield was just 4.12 percent. The gap had widened to nearly 3 percentage points — or, in finance jargon, 300 basis points.

The unusually high spreads recommend a combination of uncertainty about the economy and the Fed’s decision to stop being an aggressive buyer of mortgage-backed securities. But, in a bit of good news for borrowers, a return to normal spreads will allow mortgage rates to fall.

“We are in an abnormal market, and as the mortgage market normalizes, there is opportunity for mortgage rates to fall further,” says the National Association of Realtors’ Yun.

Although the Fed isn’t done cutting rates, it appears that bond investors have made peace with additional rate hikes, Yun says. “We know the Fed will probably raise rates two more times,” he says, “but it looks like the 10-year Treasury has already incorporated that information.”