What will happen to home prices when interest rates go up?

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When interest rates go up, home prices typically go down. This is because higher interest rates make it more expensive for buyers to take out a mortgage loan, reducing the amount of buyers who can afford to purchase a home. This decrease in demand often leads to lower home prices.

For 25 consecutive weeks, home prices have increased by double digits. However, the recent 0.75-point hike in the Fed rate has discouraged several prospective home buyers from entering the market. It remains to be seen whether this Fed rate hike will intensify competition and result in a decline in home prices, as lenders increase mortgage rates.

Inflation, Interest Rates and the Housing Market

The pandemic and its associated issues have caused a surge in home prices, with rising demand for single-family homes and disruptions in supply chains and material costs exacerbating the problem.

The situation is driven by basic supply and demand principles. As the supply of homes on the market dwindles, the growing demand for housing has created intense competition among prospective homeowners, causing home prices to skyrocket.

The rising home prices have contributed to inflation, although the sale price of a home is not included in the consumer price index (CPI). However, the cost of buying a home is a significant factor in inflation, which rose by 8.6% in May 2022 compared to the same period last year, with housing, gasoline, and food being the primary drivers.

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The increase in housing costs is due to the surge in home prices and rents. The average home price was $313,000 in Q1 2019, but by Q1 2022, it had risen to $428,700, a rise of over 31%.

Low-interest rates have kept the housing market active, with many regular and first-time homebuyers making purchases despite record home prices, thanks to manageable monthly mortgage payments.

To reduce consumer demand and lower inflation, the Fed has increased short-term interest rates three times this year, affecting long-term interest rates in the mortgage and auto industries.

How the Fed Rate Hike Affects Mortgage Loan Rates

The Federal Reserve sets the federal funds rate as the benchmark rate for U.S. banks to borrow money from each other overnight to meet reserve requirements. A hike in federal rates means that it becomes more expensive for banks to borrow money, resulting in higher costs for borrowers. The 2022 Fed rate hike is the third of its kind.

While the Fed rate hike doesn’t directly raise the home mortgage rate, it is a crucial factor behind banks charging new homeowners higher rates for 30-year mortgages.

According to a recent report on the housing market by Realtor.com, typical homebuyers should expect to pay 39% more on mortgages today than they did a year ago. Additionally, securing loans may be harder for potential homebuyers. The Mortgage Bankers Association reported that mortgage loan applications have been declining for three straight months, indicating that lending standards are becoming stricter.

Where is the housing market headed?

As Americans face pressure from high mortgage rates, soaring home prices, and record inflation, the housing and mortgage markets are bracing for the impact of falling new home prices.

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Following the Fed’s recent announcement, Fannie Mae’s chief economist, Doug Duncan, predicts a slowdown in home sales and financial activity in the coming months. Meanwhile, the Mortgage Bankers Association reported a 5% drop in mortgage applications due to high mortgage rates and weakened demand.

The American Real Estate Association’s (NAR) chief economist, Lawrence Yun, stated that higher mortgage rates would slow the housing market and reduce the pool of buyers. Redfin’s recent report on the housing market also predicts a decline in the number of homeowners and a slowdown in the boom in home sales.

According to a recent CoreLogic Homeflice Insight report in the U.S., a Fed strike to curb consumer demand could calm home buyers and cause prices to decline in some markets.

While rising interest rates are causing significant changes in the housing market, the monthly supply of new homes is increasing, and the active inventory of available real estate is slowly growing. For both buyers and sellers, depending on the domestic real estate market, this may mean that the bidding war is no longer a reliable thing as demand declines and supply begins to increase.

What this means for home buyers

Raising interest rates may alleviate the intense competition among potential home buyers seen over the past two years, but it remains uncertain whether this will result in a significant enough drop in home sale prices to offset the increase in mortgage interest rates.

The Federal Reserve’s decision to raise rates is aimed at curbing inflation and could ultimately bring balance to the housing market. However, higher interest rates can have wider effects on economic growth, employment, and potentially lead the country into a recession.

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Although home prices may have already experienced a decline, it may take some time for the market to fully rebalance. Deciding whether now is the ideal time to buy a home depends on individual financial situations and circumstances. Regardless of the economic climate, seeking the advice of a financial advisor is the wisest choice to understand the potential impact of home buying on current and future finances.

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