The Impact of Higher Interest Rates on the Housing Market

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The Impact of Higher Interest Rates on the Housing Market

Prepared by: Kyle Ryan, CFP® & Michael Menninger, CFP®

Historically low-interest rates may be going away. The rush to refinance a loan or to get a mortgage is beginning to slow down. The US has experienced all-time low mortgage rates for nearly two years, how did we get here?

Today’s Shifting Market Dynamics: What's Next?

In March 2020, the Federal Reserve (Fed) lowered the federal funds rate all the way down to nearly 0% to help spur a struggling economy. The Fed lowered rates when the global economy was in dire shape as the coronavirus pandemic caused people to lose their jobs, businesses to close, and an overall shut down of the global economy. Thus, people were pleasantly surprised to obtain mortgages at rates below 3%. It is important to note here that when you hear on the news that the Fed is raising or lowering interest rates, it is the Fed funds rates, which are not the mortgage rates, but they are indirectly related.

Now, as we transition in Spring of 2024, mortgage rates have been stagnating and are projected to decrease later this year. One may ask, why would mortgage rates decrease? Despite inflationary pressures over the last couple of years, the US economy has experienced robust growth. While this growth is a positive for the US economy, it also allows inflation to remain elevated. The Federal Reserve, which is the financial regulatory body in charge of controlling interest rates, is hesitant to lower interest rates while growth remains high, as that would lead to higher inflation. Therefore, as growth in the US economy begins to slow down, we anticipate the Federal Reserve will begin to slowly lower interest rates to retain a level of growth in the economy, while also keeping inflation in check. The question is not a matter of if interest rates are decreased, but a matter of when.

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Impact of Mortgage Rates for New Homebuyers

Homebuyers are impacted by mortgage rates if they need to borrow money to buy their home. If an individual borrowed $200,000 at a 3% rate, their mortgage payment (excluding taxes and insurance) would be $844 per month. However, if the mortgage rate was 4.5%, then the payment would become $1,014 per month, a staggering 20% increase. If a person cannot afford the additional monthly payment, they may be forced to buy a less expensive house or offer less for the home they wish to purchase. In the end, higher mortgage rates could put pressure on the rapidly growing cost of real estate.

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How Does A Higher Mortgage Rate Affect Buying A Home?

As we all know, real estate prices have rocketed in the past few years. This was due in part to the lower interest rates, which allow buyers to afford more for a home with the same monthly payment. The rise in real estate prices is impacted more by the historical imbalance between supply and demand. Far more people want to buy a home than is available on the market, so they are bidding substantially above the listing price.

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The graph above shows the movement of 15-year and 30-year mortgage rates. As you can see, while rates are roaring back up, they are just returning to pre-pandemic levels. Recency bias may make potential homebuyers believe that a 30-year mortgage at a rate of 4.45% is a bad deal, but you are still getting a rate far below the long-term average. Only a few years ago, 30-year rates were almost 5% and in the early 1980’s, mortgages rates were over 15%!

What Are Current Mortgage Rates?

Mortgage rates are impacted by a variety of factors, such as anticipated economic growth and inflation. If we exhibit sustained economic growth, mortgage rates will likely rise. Conversely, bad economic news such as a new wave of coronavirus or the impact of the Russia-Ukraine conflict in the US could cause mortgage rates to go down again. In short, as the economy grows hotter, interest rates may rise, and rates could fall with a slowing economy.

https://www.zillow.com/mortgage-rates/

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