How interest rates affect the housing market
Quick insights
- Changes to interest rates and housing prices are loosely connected, often indirectly, as both are influenced by housing demand, supply and other economic factors.
- When interest rates are higher, demand for homes may fall, which can cause listing prices to be reduced as sellers work to appeal to a smaller group of buyers.
- When interest rates are lower, demand may rise, which can cause listing prices for homes to rise as more buyers are inspired to make moves in the market.
Mortgage interest rates are often critical to homebuyers, both in terms of timing their purchase and anticipating long-term affordability. While home values are not driven by changing interest rates, trends in rates can lead to shifts in the real estate market, including listing prices.
In this article, we’ll dive deeper into the relationship between housing prices and interest rates, including the role consumer psychology can play in the mix.
How are interest rates determined?
The interest rate on a mortgage is the percentage a borrower pays for their loan in addition to the principal. There are numerous personal and economic factors which influence this rate, including:
- A person’s income
- Their credit history
- The size of their down payment
- The type of loan
- Zip code of the home being purchased
- The lender’s own policies
- The current federal funds rate
The impact of the Federal Reserve
The federal funds rate is the interest rate paid by banks for overnight lending activities. This rate is adjusted periodically by the U.S. Federal Reserve, a central bank with a dual mandate from congress to promote stable prices and rates of employment. In times of economic slowness or volatility, the federal funds rate can be a tool to stabilize or stimulate the economy.
When the federal funds rate is raised or lowered, banks pass this difference in cost on to their customers. This creates a dynamic rate environment which can affect consumers’ readiness to buy and the housing market at large. So begins a nuanced impact on the economy, including real estate activity.
When rates are high, prices may dip
High interest rates on mortgages may be a strong factor in discouraging would-be homebuyers. Settling on a mortgage with a higher interest rate can significantly impact month-to-month affordability, as well as long-term costs. When fewer homebuyers are competing for the same inventory (homes on the market), listing prices may drop to encourage more offers. Periods where homebuyers have an advantage are sometimes referred to as a buyer’s market.
When rates are low, prices may rise
Low interest rates can be extremely enticing to buyers, potentially causing a surge toward available homes on the market. FOMO (the fear of missing out) can further enhance this effect and drive those on the fence into the marketplace to buy. When many shoppers are competing for limited housing inventory, the urgency can inflate prices and contribute to a “seller’s market.” Swift changes in housing prices can cause comparable listings to lose relevance, making it important for hopeful homebuyers to track news from the Fed.
A low-rate environment can also be beneficial for developers, who may jump to take advantage of lower rates for construction loans. With time, this may improve housing supply, possibly offsetting inventory deficits and stabilizing prices.
A high mortgage rate’s impact on housing affordability
The relationship between housing prices vs. interest rates may have you wondering which is best to prioritize: a low price or low rate. While many people prefer a low interest rate, the answer to this question isn’t straightforward. Homebuying affordability depends on a variety of factors.
Buying in a high-rate market
If life circumstances have you prepared to buy during a period of high interest rates, consider several factors that can help balance the decision:
- Refinancing: If you sign a loan with a relatively high rate, you might qualify for a lower rate later through refinancing.
- Adjustable-rate mortgages (ARMs): ARMs provide an alternative to fixed-rate mortgages, with an interest rate that adjusts periodically depending on market conditions.
- Short-term cost effectiveness, long-term appreciation: Buying a home that’s valued lower during a surge of interest rates can mean a lower down payment and long-term increases in its value.
Calculating affordability for yourself
It may be beneficial to explore different scenarios with a mortgage affordability calculator that allows you to adjust the home listing price and interest rate. By using real figures inspired by your personal finances and home listings in your target area, you can see educated estimates that help you explore different possibilities.
In conclusion
Rate changes are just one of many factors that can indirectly influence housing prices on the real estate market. However, those who are considering buying a home can benefit from understanding the possible effects of mortgage interest rate trends. For help with your homebuying journey, consider contacting a Chase Home Lending Advisor.
