Why Lower Interest Rates Don’t Always Equal Lower Housing Prices

Let’s start with the good news:

Interest rates are already starting to come down a bit, and we’re seeing signals that rates will be coming down even further this year. We’ve previously discussed what factors can affect the interest rate you’ll pay for your home, and while nothing is set in stone, our friends at the Federal Reserve look ready to drop their benchmark interest rate (for the first time since 2019) at their September meeting. The interest rate set by the Federal Reserve trickles down to affect other kinds of borrowing, so mortgage interest rates will likely come down this fall, too.

What will lower rates actually mean for home buyers, though?

First, let’s all get on the same page about something: When I say “lower” rates, I’m talking about rates in the area of around 5-6%. Much lower than the 8% interest rates we were seeing in the fall of 2023, but definitely not the 3% rate your friend has (You know, the one who got lucky and bought a house in 2021 and won’t shut up about it.)

Those crazy-low sub-3% interest rates people were getting a few years ago aren’t coming back any time soon, so waiting for that kind of deal could mean missing out on the chance to purchase a home now. There has already been a fairly large reduction in the 30 year mortgage rate over the past few months, even before Jerome Powell and the rest of the Fed potentially cut rates and cause a further dip in September.

Getting a good rate absolutely does matter, don't get us wrong! Just try playing around with the interest rate variable in our mortgage calculator, you'll see the huge difference that even knocking a full percentage point off your rate can make, especially in terms of the overall amount you'll pay over the life of the loan.

In terms of overall housing costs, however, the amount you pay for your home matters a lot too. And as interest rates come down, home prices can often be driven in the opposite direction: Straight up.

The Price-Inflating Effect

The logic for why lower interest rates are seen as a good thing for housing affordability seems straightforward: Lower borrowing costs translate to smaller monthly mortgage payments, making home ownership more affordable, right? In many cases, however, low interest rates can actually worsen existing issues with housing prices!

Lower borrowing costs can lead to increased competition between borrowers, which leads to inflated home prices, and ultimately a more difficult path to homeownership for many aspiring buyers.

One of the frustrating things about lower interest rates is their tendency to fuel demand in the housing market. Thousands of potential borrowers have been checking mortgage rates for the past year, thinking “nope”, and going on with their day. Those people still want houses, however, and the further rates drop, the more of them will decide it’s time to start house hunting.

When borrowing costs are low, more people are incentivized to enter the market, leading to increased competition for an already tight housing supply. This heightened demand can drive up home prices, often very quickly. As a result, even though part of monthly mortgage payment may go down a bit due to reduced interest rates, homes themselves could start costing a lot more. If interest rates go down another 2%, but home prices jump 15% because a lot of buyers enter the market at once, the 2% interest rate reduction isn't helping very much at that point.

This problem is particularly pronounced in markets with already tight housing inventory, which is pretty much everywhere these days.  Here, low interest rates can spark bidding wars, pushing home prices far beyond their intrinsic value. This not only makes it more difficult for first-time buyers to enter the market but also creates a sense of urgency and the dreaded sense of FOMO, or Fear of Missing Out. The effect this can have among potential buyers can’t be overstated, and it can lead to impulsive decisions and overpaying for homes.

Speculative Investors Are The Worst

Low interest rates can also attract speculative investors to the housing market. Yep, those people.  These investors, often with access to significant capital, can purchase multiple properties, further reducing the available housing stock for owner-occupiers. This creates an artificial scarcity, driving up prices even more, and making it more difficult for individual buyers to compete.

Moreover, investors may be more willing to pay above-market prices for properties, often in an all-cash transaction. They do this because they're anticipating future price appreciation in the housing market. This can create a self-fulfilling prophecy, where rising home prices become the norm, further exacerbating affordability challenges for first-time buyers and those with limited budgets.

In Conclusion

Trying to time the housing market, and find the "perfect" time to purchase or refinance your home, is a game that few people win. Instead, if you've been on the fence about whether rates have fallen enough to make homeownership worthwhile, here are two important points from above to remember:

1. Rates have already fallen quite a bit from their highs of a year ago, and 3% mortgage rates aren't coming back any time soon. 
2. As rates continue to fall, more and more people who have been waiting on the sidelines will start to enter the housing market, which could drive home prices much higher

If you'd like more information on what may be the best option for your unique circumstances, give us a call at 888-353-4449 and one of our mortgage loan specialists will be happy to talk to you. There's no obligation to move forward with anything if you call to talk to us, we're just here to help!