Rising interest rates strike fear and dismay into the hearts of home buyers, sellers, and real estate professionals—and with good reason because when rates rise, home sales tend to decline.
It’s a common misperception that rising mortgage rates cause house prices to drop, but in fact, historical trends show a positive correlation only between rates and sales, not rates and prices.
Correlation is a fancy term used in statistics to indicate that two trends move in the same direction or opposite directions. Trends that move in the same direction are said to be positively correlated. Trends that move in opposite directions are described as negatively correlated.
A correlation, whether positive or negative, doesn’t imply causality. Sales of surfboards and sunblock might be positively correlated, for instance, but that doesn’t mean sales of one cause sales of the other.
The Federal Reserve generally raises its benchmark federal funds rate when the U.S. economy is healthy, unemployment is relatively low, employees can demand higher wages, and fears of inflation are on the horizon. Once the Fed moves the funds rate higher, banks and other lenders tend to increase the market rates consumers pay for mortgages and other loans.
Rising incomes mean more people can afford to buy a home and with a bigger mortgage, which increases demand for homes. Higher demand pushes home prices higher. But at some point the combination of higher home prices and higher mortgage rates makes homes unaffordable for some people who want to buy even with higher wages. This effect can multiply. As first-time home buyers pull back, fewer existing homeowners can sell their current home and trade up or down to a new one.
When homes are less affordable, fewer people can buy them, resulting in fewer sales. That’s hard news for home sellers, realty brokers, mortgage lenders, and other professionals whose livelihoods are tied to home sales. Fewer sales means less call for home inspections, escrow or settlement services, and the like.
By the way, rising interest rates also make real estate less appealing for investors. Rather than buy property, they might decide to purchase stocks, bonds, or other assets instead, further reducing demand for homes and home sales.
Still, history doesn’t always repeat itself and factors in today’s economy and housing markets could alter the pattern. All-cash buyers, demographics, construction of new homes, and globalization of real estate markets could all change the interplay of mortgage rates, home prices, and home sales.
Demand for homes is also intensely localized. Trends in one place can be quite different from trends in another. Buyers should keep that in mind as they work with their realty broker to locate the home they want buy.
Marcie Geffner is an award-winning reporter, editor, writer and author covering a number of topics including real estate, mortgage and banking. She is currently a full-time freelance reporter. Marcie is a former board member of the National Association of Real Estate Editors and remains an active organization member.
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