Impact of interest rates on the housing market

The housing market is complex. Prices are determined by a wide variety of factors which are local, regional, national and global. While basic concepts like supply and demand come into play, other things like mortgage rates, inflation, and even economic conditions in other countries all influence the housing market.

We will break down the impact of various factors on the cost of housing.

The federal funds rate and the 10-year bond rate

The federal funds rate is a benchmark interest rate determined by the United States Federal Reserve. This rate is the interest rate that banks charge when they lend money to each other overnight.

This rate is called the reference rate because it serves as a reference for many other interest rates. Everything from savings accounts to credit cards sets interest rates in part based on changes in the federal funds rate.

Bonds, such as 10-year US government bonds, also have interest rates that are influenced by the federal funds rate.

Historically, the interest rate on 30-year mortgages has moved in parallel with changes in the rate on 10-year Treasury bills. As 10-year bond rates rise, mortgage rates rise. The same is true for rate cuts.

Higher interest rates mean higher monthly mortgage payments, which can make it harder for many people to buy a home.

Inflation and housing

Inflation is the process by which money loses purchasing power. For example, inflation over the past year was 8.5%, so something that cost $100 a year ago would cost $108.50 now.

Inflation affects the housing market in several ways.

On the one hand, inflation raises house prices just as it raises the price of all goods.

However, one of the goals of the Fed is to try to control inflation and keep it low and stable. If inflation rises significantly, the Fed could raise the federal funds rate to reduce the money supply and reduce the rate of inflation.

This increase in the federal funds rate can cause mortgage rates to rise, and rising mortgage rates can reduce demand for home purchases, causing home prices to fall.

Current interest rates

Current mortgage interest rates, which are influenced by the federal funds rate and other market rates, influence the price of housing.

When the rates increase, this leads to an increase in the monthly payment for a loan of the same amount. For example, at an interest rate of 4%, a $250,000 mortgage would cost $1,194 per month. At 6% interest, the same loan would cost $1,439. The effects are even greater for larger loans.

According to Allyson Waddell, head of agent success at RealtyHop, a national housing website, recent rate increases have had a big impact on buying power. “With mortgage interest rates around 6%, American buyers have 24% less buying power than a year ago.”

As rates go up, people can’t afford more expensive homes, which can kill demand and drive prices down.

Housing inventory and new construction

Supply and demand are two simple factors that influence the price of all goods and services. If more people want something, prices go up. If more of this thing becomes available, prices go down.

Housing stock can be impacted by many factors. New construction is pretty much the only way to increase supply in the housing market. However, new construction can be slowed by rising labor and material costs. Rising interest rates and falling house prices are also slowing construction, limiting the increase in supply in the housing market.

“Housing construction is not increasing to the level needed to combat the shortage,” Waddell says. “Interest rates could stay at this level for some time, and a buyer will see no benefit in waiting to buy a property only to wait for a reduced rate.”

Politics can also play a role in housing construction, with zoning restricting the construction of things like apartments which can create additional housing supply. In recent years, large investors have bought properties to turn them into rentals, further reducing the supply of homes to buy.

It is rare for housing markets to experience significant increases in supply. Population growth and other factors naturally lead to larger increases in demand than supply.

Local Housing Market Factors

Local factors affect housing prices in several ways, usually by affecting housing demand.

For example, if a major employer in the area closes and many people lose their jobs, this can reduce demand for housing and cause prices to fall. Other factors, like the quality of the school district, nice weather, and proximity to things like big cities or amenities can drive up demand.

The level of supply and demand in a local area has a significant impact on prices in that area. It also determines whether buyers or sellers have more bargaining power.

For example, Seth Bellas, production branch manager at Churchill Mortgage, noted that lower demand from buyers has made sellers more willing to negotiate.

“Higher rates are putting a strain on lower-middle-class borrowers due to higher payments, but the downturn has also allowed, in some cases, those same buyers to cover closing costs and get deals accepted. with the possibility of selling their current home. We also saw an increase in VA and FHA offers being accepted, whereas in a more competitive environment, these offers were often snubbed by sellers,” he says.

Given the current conditions, what is the next step?

Predicting the future of the real estate market is difficult even for experts. Nobody really knows how things will change in the future.

On the one hand, interest rates have risen significantly over the past few months and the Fed has done nothing to give the impression that it was planning to slow down. However, housing prices have skyrocketed over the past few years, increasing by more than 30% since 2020.

Some believe that rising rates and an economic slowdown will force prices down. Others insist that inflation and the reduction in housing supply caused by a slowdown in new construction and the purchase of inventory by institutional investors will lead to price stability or a continuation of their rise.

Find a trusted real estate agent

No matter what happens to the real estate market over the next few months and years, if you’re considering buying or selling a home, it’s a good idea to work with a knowledgeable real estate agent. A good agent can give you insight into your local market and determine a fair price for properties in your area.

Leslie M. Gill