Rate Hikes & Housing Prices

Q: The Federal Reserve has been hiking interest rates all year. Those increases will push down demand, which is supposed to push down prices. But is it possible their enthusiasm for rate hikes will raise some costs, e.g., if higher interest rates lead to less new housing construction, will that limit supply so much that housing prices stay high or even increase?

It’s certainly true that the Federal Reserve has been aggressive in raising the federal funds rate this year. It has increased from 0.50% in March to 4.00% as of November 2022.

These rate hikes introduce an affordability question to the housing market. If the financing side of acquiring housing goes up, because interest rates are higher, then the consumer’s monthly payment is going to eat much more of their disposable income. Consequently, higher interest rates will ultimately make real estate less affordable.

So, the housing cycle is very much dependent on interest rates, and prices must come down for the affordability component to stay even close to where it was.

But what does this mean for housing prices?

They will almost certainly come down. Economist after economist is predicting housing prices to fall. Jeremy Siegel, Wharton Professor of Finance, told CNBC, “I think we're going to have the second-biggest housing price decline since post WWII period over the next 12 months.”

Whether it’s that big a decline remains to be seen but borrowing costs can only increase so much before they begin to impact the price of homes. The average household only has so much disposable income that they can allocate toward a monthly home payment. If more of that is going to the borrowing piece, then less of it can go to the principal piece.

To put some numbers to it: with a 30-year mortgage at 3%, the borrowers would be looking at something like a $3,333.73 monthly payment. At 6.5%, it's over $5,000. A $550,000 mortgage at 6.5% from a monthly statement standpoint is the same as an $800,000 mortgage at 3%. That’s a big difference between what borrowers can get now versus a year ago.

That said, this doesn’t mean the fall in prices will happen quickly. While the housing market is very sensitive to interest rates, there’s a sizable lag before the effects realize. Even if demand for housing moderates quickly, low existing inventory can still create a lot of competition for those homes in the short-to-medium term, and that means home prices can remain high for quite a while.