How Higher Interest Rates Affect the Housing Market

If you’re thinking about buying a home or refinancing, you need to know that rising mortgage rates are affecting the housing market. Mortgage rates have been increasing for months. The most recent analytical report by the Federal Reserve shows that the “repo” rate has increased, meaning banks are borrowing money from each other. The repo rate is set by banks and changes based on how much they feel they can lend, versus what they believe they can receive in terms of their funding costs.

What is the relationship between mortgage rates, inflation, house prices?

There has been a small but positive correlation between mortgage interest rates and house price increases since 1976. To clarify, there is a weak correlation between rising mortgage rates and rising home prices. The increase in mortgage and interest rates has been a consistent predictor of inflation, reduced unemployment, and faster wage growth. In the past, the rise in mortgage and interest rates are connected with better economic expansion, flower unemployment, and stronger pay growth.

Rising Rates Impede House Price Appreciation

Studies of the past correlation between mortgage rates and property prices did not show an increase in interest rates. Real estate price appreciation slowed dramatically during those times. A few statistics show that housing price growth reduced from 12.9% to 1.1% between September 1979 and March 1982. It slowed from 3.2 percent in September 1994 to 2.6 percent in February 1995. Although actual house price appreciation was negative for some eras, nominal home price appreciation was never negative before the beginning of the recession.

Back to Normalcy?

Several factors may stand as a support to market growth, including a robust economy and rising inflation. 

Demand for housing may increase as a result of rising salaries and falling unemployment rates. Buyers may anticipate rent increases to be at least as rapid as the rate of inflation (or faster, if demand is strong). As opposed to renting where your housing expenses are subject to annual rises, house ownership allows you to stabilize a significant chunk of your budget and protect your buying power from inflation.

Furthermore, even though the upfront costs of homeownership for first-time buyers are greater than the monthly expenses of renting, inflation might alter the calculations, and the buyer may decide to purchase, regardless. 

Potential homebuyers prefer the certainty of a fixed mortgage payment over the uncertainty of potentially higher rent payments in the future. Investors are ready to pay a premium since they can get a greater rate of return from rental revenue and reduce their financing risks.

Conclusion

What higher rates tell us about house price appreciation has been the subject of much conjecture but little data. This indicates that higher mortgage rates have a chilling effect on house price growth and may dampen activity in the housing market. The current lack of house availability wasn’t present during previous times when rates rose rapidly, which may mitigate today’s slowdown. Higher mortgage rates seem to have a significant impact on affordability, but it is unlikely to induce a reduction in property values.