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Could Rising Interest Rates Cool the Housing Market? Thumbnail

Could Rising Interest Rates Cool the Housing Market?

If you follow RiversEdge Advisors on social media or read our emails, you know that Fed Chairman Jerome Powell has committed to raising interest rates to combat inflation. At the FOMC meeting on May 4th, he jacked up rates by half a percentage point. This was both the largest increase since 2000 and the first time the Fed has raised rates in back to back meetings.

But, before you freak out, you must know that he ruled out a larger hike that was expected to take place later this year. This news buoyed investor sentiment and stocks rallied that day in response to the news. Some are criticizing this move, saying it’s not going to be enough to stave off inflation, but only time will tell if this “tightening” measure will be enough. 

But what most of us are concerned with is how rising rates will affect our financial lives. And with the housing market off on a runaway train for the past two years, how will rising rates affect mortgages, real estate, and home buying? Many are interested in buying a first home, a second home or investing in real estate but have been waiting for things to cool off. Could rising rates be the ticket? 

Possibly, yes. Here’s why.

Current Real Estate Conditions 

From 2013 to 2021, the average interest rate on 30-year fixed rate mortgages has remained near historic lows. Even though they have started to rise in 2022, they still remain relatively low.   

These conditions made homebuying easier as low interest rates made buying more appealing. Just look at this example from Investopedia to see why:

“If Johnny Home Buyer wants a 4% rate on a 30-year fixed mortgage on a home worth $400,000, his monthly mortgage payment would be $1,900. But if Johnny only qualified for a 5% rate on a 30-year fixed mortgage, his monthly payment would rise to $2,138. A 1% increase in interest raises Johnny's payment by $238, or roughly 13%.”

With interest rates at historic lows, demand for real estate increased, but the supply of constructions materials for new homes was thwarted due to pandemic-related supply chain issues which pushed new home costs through the roof. The result? Houses all over the country are still selling for 10-15% over asking price more often than not. It is a seller’s market if we’ve ever seen one. It has been increasingly difficult for buyers to lock in what they want at a price they can afford. Even with cash in hand, there are simply too many people out there vying for the same properties. The competition Is fierce, and we know our real estate friends are tired.


Increased Equity 

Now, you might be thinking. Yeah, but aren’t homebuyers enjoying more equity in their homes as a result? And the answer is also yes. Many individuals took advantage of this and did a cash out refinance on their homes. Some folks have sold their properties for hundreds of thousands—even millions—over what they paid for them only 1.5-2 years earlier! 

But, for those trying to enter the real estate market, these conditions have been tough. Buying at the peak of the market is always a huge risk. You never know how much the market will stabilize, when, and for how long before you can see a return on your investment.


Rising Rates Could Cool the Housing Market, Making Homebuying “Easier” Again 

Here’s the conundrum. Buying is hard right now. Not because of rates, but because of demand and overvalued home prices. It’s hard to find what you want and then justify paying such an escalated price for it not knowing what the housing market will do. 

But, there is good news, depending what side of the fence you fall on.

1. Mortgage rates will likely increase as rates are bumped up.

     When interest rates rise, mortgage rates tend to rise, also. This is because they tend to move in the same direction as the federal funds rate.


    2. Higher rates mean higher payments and loan costs. 

    Higher interest rates, however, translate into higher mortgage loan costs. This is because rising rates make homes more expensive for buyers (see monthly payment example above), thereby reducing the demand for home purchases.

    3. Demand should slow with rising rates. 

    Typically, when mortgage rates increase, affordability decreases, and demand slows. Reduced demand also hurts sellers as they need to reduce the prices of their homes in order to attract buyers.


    Reduced Demand Could Be Just What Potential Buyers Need to Enter the Market

    The silver lining is that this reduced demand could be just what potential homebuyers or real estate investors need to enter the market with less overvaluation risk—even though they might be paying slightly more over the course of their loan than they would have a year ago.

    Of course, we still encourage potential buyers to lock in the best rates they can. You never want to pay more for something than you have to. So, that being said, there might be a sweet lull in demand before rates rise too high where buyers might find the perfect opportunity to acquire what they’re looking for.

    Key Takeaway: Low interest rates tend to increase demand for property, driving up prices, while high interest rates generally do the opposite.


    Always Keep Your Big Picture Goals in Mind

    If buying real estate is on your radar, you’ll want to discuss your buying plans with your advisor sooner rather than later while interest rates are still relatively low. Now will be the time to start exploring to see if you can lock in a decent rate and secure the type of property you need before mortgage costs rise higher.