Interest rates are the cost of borrowing money. These rates fluctuate over time for various reasons, often based on the Federal Reserve’s decisions. If you are thinking about buying a home, you certainly want the lowest interest rate possible. However, you also need to consider how interest rates, on a larger scale, impact home prices.
In 2022, the Federal Reserve began increasing interest rates to reduce inflationary risks across the U.S. In doing so, the price of borrowing money to buy a home grew. As interest rates climbed, they slowed demand for home loans, leading to fewer people listing their homes for sale (because they didn’t want to buy new ones at high costs), which could lead to lower prices over time.
As a home buyer or seller today, you should understand how interest rates impact all aspects of home prices, including mortgage affordability, buyer demand, and the activity in the real estate market as a whole.
How interest rates impact housing affordability
Interest rates directly impact how affordable the housing market is.
- When interest rates rise, it becomes more expensive to obtain a mortgage loan. This leads to a drop in housing demand. Over time, the drop in demand can lead to lower home prices.
- When interest rates fall, it is easier for people to buy a home because their monthly payments are lower. More people are likely to enter the market to buy a home because it is more affordable to do so.
How rate hikes or cuts affect buyer behavior
Take into consideration what happens when interest rates are lower. If a person purchases a home with a $240,000 loan, with a 30-year fixed rate and a 5% interest rate, their monthly payment is about $1288. The same loan, with the same terms and length, with a 7% interest rate, now has a monthly payment of $1597, much higher.
Because of this increased cost each month, fewer people can afford to buy a home. When rates go up, fewer people obtain a loan, leading to fewer sales in the real estate market overall. Some people may still be able to afford the highest interest rate, but that higher cost of borrowing makes it less desirable overall to buy right now. Ultimately, fewer people want to enter into the market.
Use a mortgage calculator to help you compare various scenarios in your area. The differences can be shocking.
Future interest rate trends and how they could impact home pricing
Quite a bit of speculation exists on what could happen in the real estate market in the coming months and years if the Federal Reserve cuts the key lending interest rate. The Fed does not always reveal early what steps it will take at the quarterly meetings to update interest rates. However, many people speculate that the Fed may keep rates the same as they have been because inflation continues to rise.
Others believe interest rates could fall slightly. If that were to happen, it could mean that the mortgage lenders pass on the savings to their mortgage borrowers. Interest rates could be slightly lower, making it more affordable to buy a home.
If the Fed does not change rates, it may be likely that home prices continue to remain the same or fall slightly if demand continues to fall back. Over time, the Fed is likely to start lowering that rate, and that could, ultimately, mean more affordable home loans.
Strategies for buyers and sellers in a rising rate environment
As interest rates remain high, both buyers and sellers must consider their ultimate options and strategies.
For home buyers who cannot wait for lower rates, consider these strategies:
- Work to improve credit scores as much as possible to qualify for the lowest interest rates available.
- Have a larger down payment. A higher down payment means less borrowing and lower overall costs.
- Consider an interest-only loan, which may offer a lower monthly payment now while rates are higher. You can refinance at a lower rate should terms improve in the future.
For home sellers ready to make the move, there are several strategies that can help:
- Sell sooner rather than later. With fewer buyers and sellers on the market, your home could stand out. Home prices may drop down the road, so selling now is often desirable.
- Make sure your home is well-priced. An appropriate price will make your home more competitive, especially in areas with ample demand for other homes on the market.
- Work with a skilled agent to market your home in an effective manner.
Tips for leveraging low rates to secure favorable deals
If you are a home seller and have the opportunity to offer seller financing, you may be able to offer lower interest rates to get the home buyer you are interested in. Seller financing is an option some buyers may find interesting when bank loans are too expensive.
Takeaway
Interest rates have a direct impact on home prices and market activity. All market stakeholders, including buyers and sellers, must pay attention to the changing market climate and adjust their real estate strategies accordingly.
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