The weakness was nationwide, and December's reading was also revised lower. Pending sales, which are an indicator of future closings, were 3.8 percent lower than January 2017.

"The economy is in great shape, most local job markets are very strong and incomes are slowly rising, but there's little doubt last month's retreat in contract signings occurred because of woefully low supply levels and the sudden increase in mortgage rates," said Lawrence Yun, chief economist for the Realtors. "The lower end of the market continues to feel the brunt of these supply and affordability impediments."

Not only are home prices increasing at a faster clip, mortgage rates are now half a percentage point higher than they were at the start of this year. They began rising in January and have yet to retreat.

"With the cost of buying a home getting more expensive and not enough inventory, some prospective buyers are either waiting until listings increase come spring or now having to delay their search entirely to save up for a larger down payment," Yun said.

Despite the drop in signed contracts, Realtors reported strong buyer traffic in January, but the number of listings fell to an all-time low, down 9.5 percent compared with January 2017. Adding to the inventory drought, home sellers are now staying in their homes longer, an average of 10 years, which is an all-time high since the Realtors began tracking this measure in 1981.

Pending home sales in the Northeast fell 9 percent for the month and were down 12.1 percent compared with a year ago. In the Midwest, sales fell 6.6 percent monthly and 4.1 percent annually. Pending home sales in the South declined 3.9 percent for the month and were 1.1 percent lower than last January. Sales in the West were down 1.2 percent monthly and 2.5 percent annually.

The housing market clearly needs more new construction, and homebuilders are increasing production, but slowly and mostly in the move-up market, not at the entry level.