Interest rates are the most crucial factor when it concerns real estate transactions. The difference between being able to purchase a home and being priced out of the market entirely can be determined by a relatively minor shift in interest rates. When the interest rate, or the cost to borrow money, rises, many other goods and services and shelter costs go up. This is especially true in the housing market, where even a slight increase in interest rates can have a significant impact.
Here are the Seven ways an increase in interest rates can influence the housing market:
- When interest rates are higher, it becomes more difficult for the prospective buyer to qualify for a loan and more expensive to take out a loan to pay for the purchase of a home. This might lead to a decrease in the demand for properties, which in turn can lead to prices falling. On the other hand, reduced interest rates make it less expensive to borrow money, which may lead to an increase in demand and prices.
- Rental property investments become more costly for investors as interest rates rise. The result may be a decrease in capital going into the rental market and, consequently, increased rental costs, ultimately leading to higher rents. Investors who own rental property may also be affected by rising interest rates and might try to transfer this burden to their tenants. But if tenants can no longer afford their rent, they may have to move out, leading to homelessness. Additionally, this can leave investors with vacant properties and a loss of income.
- Mortgage payments tend to rise alongside interest rates, especially with variable mortgages and refinancing fixed-rate mortgages.
For those who are already homeowners, a rise in interest rates can mean having to refinance at a higher rate. Some homeowners can not manage to pay their mortgages as when the interest rate rises, the cost of food and other commodities also increases, thereby hitting them from all spheres. This can make it challenging to keep up with mortgage payments and may eventually lead to foreclosure. - Among the adverse effects of increased interest rates is a decline in home equity. This is because a homeowner’s equity decreases when their mortgage payment increases. The fundamental reason for this is that when the interest rate on their mortgages rises, they pay less each month toward the principal, the actual amount borrowed and more toward the interest, which is the cost of borrowing.
- Even lenders are pretty conservative in screening the buyer and providing a loan and only approve buyers with low default ratios when interest rates are high. But this might require the buyer to put a sizable sum of money towards the down payment to get financing approved. Therefore, the buyer has to pay a high down payment plus an enormous monthly mortgage. This can make it more difficult to afford a home and lead to fewer people buying homes.
- Rising interest rates have a direct impact on home buyers’ confidence. As rates increase, buyers feel less confident about their ability to afford a home. They are more likely to put off buying until rates stabilize or drop again. This lack of confidence can have a ripple effect on the housing market, leading to fewer sales and a slower overall market.
- Additionally, the psychological impact of rising rates can be significant, leading buyers to hesitate when they might otherwise have been confident about purchasing a home.
It’s also likely that a drop in property value would accompany an increase in borrowing rates. Now, if, as a seller, you plan on selling the home, you might discover that the sale process takes more time than you anticipated or that you have to reduce the amount you are asking for to attract potential purchasers. Thereby making it a buyers’ market but still with very few active buyers. In general, increased interest rates can negatively affect the real estate market, resulting in fewer sales and lower prices.
The opposite is true for the real estate market: declining interest rates are often welcome news. Increased demand and higher prices may result from lower interest rates because they make homebuying more affordable. In short, rising interest rates can significantly impact the real estate market. Keeping an eye on interest rates, reading the market, and being ready to act swiftly if they start to shift are all crucial to buying or selling a property.
But, The Truth:
Low-interest rates also encourage mortgage refinancing, which can delay or even stop defaults and foreclosures. Since the beginning of covid inspired quantitative easing in 2020, interest rates have remained historically low. Up until rising inflation triggered quantitative tightening and increased the rate in 2022. Low rates initially acted as great news for home buyers, as it has helped to make purchasing a home more affordable. But as witnessed in later parts of 2020, the year 2021, and the beginning of 2022, affordable and low financing rates wreaked havoc on home prices in reality. Many investors and builders took advantage of low-interest rates, priced out first-time home buyers, and drove home prices.
However, as interest rates have begun to rise since February 2022 with subsequent rate hikes, home buyers have become less confident about their ability to afford a home. In reality, home buyers were priced out of the market by investors for a long time before interest rates started rising. Investors had bigger pockets and portfolios and took financing at low-interest rates. And now, as with rate increases, even though real estate investors are out of the market, high-interest rates have made it impossible for regular home buyers, especially first-time home buyers, to finance and purchase a home due to many factors mentioned above. In conclusion, the price paid by buyers sitting on the fence waiting for the right time and value to afford a home is relatively high. These sudden interest rate fluctuations over a short period have done nothing more than shoot down their dream of homeownership.
