How Rising Mortgage Rates May Affect the Real Estate Market

Mortgage rates remain historically low, but they are rising fast

Ever since the housing market began to recover in 2011, mortgage rates have remained relatively stable and relatively low, with the rate for a 30-year fixed mortgage hovering just below four percent for the past few years.

Recently, though, rising interest rates have sent mortgage rates ticking upwards, and some analysts are forecasting a five-percent mortgage rate before the end of the year.

Rising mortgage rates will likely have myriad effects on the housing market. Here’s what every potential buyer, seller and real estate professional should know as rates continue to rise.

Rising mortgage rates are the result of a healthy economy.

Interest rates have remained low since the housing collapse a decade ago, a strategy the U.S. Federal Reserve has employed to spur economic growth. The economy has seen steady growth for the past nine years, and as unemployment nears pre-Recession numbers, the Fed is beginning to slowly raise interest rates to avoid inflation. Most recently, interest rates were raised December, and we’re likely to see further hikes before the end of 2018.

That’s a strong sign for the economy at large, but it may mark the end of a buyers’ market in real estate.

A higher rate may not affect home prices.

Housing prices are not typically directly affected by mortgage rates. Because mortgage rates are the result of a growing economy, wages are climbing in step and buyers are able to absorb the additional cost. Demand, then, is unlikely to fall significantly, which is what would trigger a drop in home prices.

However, that balance can begin to shift if climbing mortgage rates begin to outpace wages. In the long term, we may see a drop in pricing, but for now, predictions of rising rates will only drive demand.

Many buyers are eager to buy now.

With mortgage rates expected to climb for the foreseeable future, many prospective buyers are feeling the pressure to lock in a fixed-rate mortgage now. For the same reason, potential sellers are motivated to keep their properties rather than give up a relatively plum mortgage rate.

The market is contracting.

As potential sellers re-think their strategy and settle in to take advantage of their low fixed-interest mortgages, fewer houses will be available on the market, which means competition among buyers will increase, driving prices up and pushing buyers into new, potentially less desirable markets.

Many will look to new-home building to mitigate the lack of re-sales. Unfortunately, that does not appear to be in the cards, at least not immediately.

New-home building is down.

While demand for housing is increasing in the short term, higher mortgage rates coupled with reduced tax breaks for homeowners have diminished purchasing power for buyers, which is making builders squeamish about investing in expensive new development projects. Those concerns are compounded by rising costs in construction materials, labor and land.

New-home sales lagged in 2017 and don’t look much better this year, causing builders to think carefully about where and in what type of homes they invest. Many builders who are looking for development opportunities are focusing on the high-end of the market, where buyers are less affected by rising mortgage rates and a single project can offer a much a sizeable pay-day.

Demand will likely increase at the low end of the market.

As builders focus more on the high-end of the market and buyers become increasingly eager to purchase before mortgage rates increase, demand at the lower end of the market is likely to increase. That heavy competition for entry-level homes is likely to turn-off millennial buyers, who are already less likely to purchase than their counterparts in previous generations.

Most buyers looking for an inexpensive home are going to face an uphill battle for the foreseeable future, at least until demand grows enough to spur builders to return to the entry-level market.

Don’t freak out.

The common thread throughout this primer is that the real estate market is reactive. If market forces are prohibiting you from buying or selling a home at the price you want now, you are probably not alone, and you might not have to wait too long for the market to respond. At a very basic level, if interest rates make homes less affordable for most buyers, demand will eventually go down, and when demand goes down, prices will eventually follow.

We’ve seen firsthand the volatility of the real estate market. Making major investment decisions based on market predictions can be a dangerous endeavor. Most homeowners would do best to work with a financial advisor to find out what they can afford, and then go after that property when it becomes available.