What Does the Interest Rate Hike Mean for the Housing Market?

Couple exploring interest rates for a new home

In its continued war against inflation, the Federal Reserve raised interest rates for the sixth straight time this November. This is a big deal for those looking to buy a house (especially first-time homebuyers) because whenever the Fed hikes interest rates, mortgage rates usually increase as well.

In fact, as of the writing of this article, the average interest rate reached 6.90% for a 30-year fixed mortgage—the highest its been since the early 2000s. This article will answer the following questions about Fed rate hikes and real estate: How does the Fed interest rate impact mortgages? Should you buy a home right now? What do rising interest rates mean for sellers?

Home prices remain high in Greenville, SC, and nationally. While there is much that remains uncertain in the housing market today, we know that housing prices went up in nearly every market across the country following the pandemic. The Covid Spike Theory, which argued that housing prices increased after Covid because of less housing inventory combined with increased consumer demand for new homes, turned out to be more persistent than many initially thought.

With the price of many things going up due to levels of inflation not seen since the 1980s, the real estate market was not immune. Skyrocketing home prices are among the many reasons the Fed began to raise interest rates in the first place.

Why is the Fed Raising Interest Rates Now?

The reason the Fed has raised its interest rates six times now in 2022—and will likely raise them again in December—is due to a national inflation rate that has topped 8% on the year. You might hear commentators discuss the Fed’s target inflation rate, which is 2%. What this means is that in ideal circumstances, the Fed would like to see prices rise by 2% annually.

Some people seem to think this means that the Fed will continue jacking up rates until they reach a target of 2% inflation. But the whole picture is more complicated. The Fed is trying to combat inflation while being mindful of the fact that raising rates could tip the American economy into a recession.

The Federal Reserve doesn’t want to lead the country into a recession. When they talk about a “soft landing,” they are referring to rate hikes that are well-timed enough to reduce spending without tanking the economy in the process. The goal of the Fed in raising rates is to encourage people to spend less and save more, thus reducing inflation.

A quick note: the Federal Reserve does not control mortgage rates. That is to say, the Fed does not tell mortgage brokers and commercial banks to increase their rates. Instead, the Fed controls the federal funds rate, which is the interest rate banks charge each other for overnight loans.

But the federal funds rate influences other interest rates. When this rate goes up, the cost to borrow money to purchase a home typically rises as well.

Mortgage rates had already been on the rise in 2022 before the Fed started increasing the federal funds rate because many banks and mortgage underwriters saw what was on the horizon and wanted to protect their bottom line.

What Do the Fed Rate Hikes Mean for Home Buyers?

Higher interest rates cost prospective homebuyers money. Higher rates can also impact the total amount you can borrow in purchasing a home. When the Fed was slashing rates in 2020, you could afford a lot more home than you could today because mortgage brokers take your debt-to-income ratio into account when determining the size of your loan.

But how much more money will higher interest rates cost you? Let’s look at a concrete example to see precisely how much more buying a home today will cost you compared to just 12 months ago.

Bob and Cheryl bought a home in November 2021 for $350,000 at a 3.33% interest rate—the average at the time for 30-year fixed mortgages. Lisa and David purchased the same house today at our current 6.90% interest rate.

30-Year Fixed Mortgage Bob and Cheryl Lisa and David
Home Value $350,000 $350,000
Down Payment $70,000 $70,000
Loan Amount $280,000 $280,000
Interest Rate 3.33% 6.90%
Monthly Payment $1,539 $1,539
Total Interest Paid Per Year $9,324 $19,320

As you can see, interest rates matter quite a bit when it comes to buying a home. Even though both couples paid the exact same amount for their homes with identical down payments, Lisa and David will end up spending nearly twice as much each year toward interest. This number is also reflected in Lisa and David’s higher monthly mortgage payments.

If Lisa and David stayed at the same interest rate for the next 30 years, they would wind up paying $299,880 more for the same house compared to Bob and Cheryl. This is a significant amount of money.

Should You Buy a House Now?

High interest rates can be a tough pill for many prospective homebuyers, especially first-time homebuyers, to swallow. Do the numbers above mean you shouldn’t buy a house right now? It all depends on you and your financial situation.

Buying a home is a very personal decision that typically involves a number of factors: Are you still renting? Do you plan on having a family and desire a larger home? It would be impossible for us to tell you when you should buy a new home, but here are some things to consider when looking for a new home in today’s current economic climate:

  • You can always refinance your home purchased today at a lower interest rate tomorrow. There are times when you should and shouldn’t refinance your home. If you recently purchased a home or plan on purchasing a home, you won’t be able to refinance at a lower rate now given how high they are across the board. But when interest rates drop, you can lock in a new mortgage at a lower rate.
  • Renting is a terrible deal. Even in the worst of circumstances, buying a home almost always makes better financial sense than renting. When you’re a renter, your landlord can more or less increase your rent at any time. More importantly, as a renter, you’re not building any equity in your property. The real estate market will go up and down, but renting will always be a bad deal. Imagine if Lisa and David from above paid $27,660 dollars renting each year, and not a nickel of that went to pay the principal on their mortgage.
  • Do you want to wait it out? When we talk to prospective homebuyers, we often find that they don’t want to wait for interest rates to go down to start shopping for a home. In fact, we usually discover that the mortgage rates don’t factor much into their decision at all. Those who have the means to purchase a home have often been thinking about it for a long time, and don’t necessarily want to wait for some point in the distant future when mortgage interest rates go down to start their new lives.
  • Will the cost of homes actually come down? Many housing market experts talk about a cost correction in housing. Because housing prices rose so quickly over the past year, they will certainly come down in 2023, right? The answer to this question is: maybe, we’ll see, and who knows? As has been pointed out, the most prominent, long-term issue when it comes to current housing prices is our housing supply shortage. Following the housing crisis of 2008, new construction disappeared for a long time, leading to our housing supply shortage. This environment should keep the price of housing elevated for some time. One might expect minor home price corrections in certain real estate markets, but we wouldn’t advise homebuyers to bank on cheaper houses anytime soon.

Should You Sell a Home Right Now?

In 2021, home prices rose by an astounding 16.9%, which was the largest 1-year spike in home prices on record. While prices have come back down to earth slightly since the Fed began rate hikes earlier this year, the price you can get for your house is still significantly higher than it was just a couple of years ago.

As the rate hikes continue, we should expect that the price of houses will continue their slight downward trajectory. Some potential buyers will decide to put off their purchase of a new home—the time a new home remains on the market has already doubled from January 2022 to November 2022 from 2 months to 4 months.

At the same time, many other buyers will decide to jump back into the market now that there are more houses available. The housing market for sellers went from white hot to only red hot.

While some prospective homebuyers may be unwilling or unable to purchase a house in our current economic climate of rising prices and rising interest rates, the reason you’ll most likely be available to find a buyer has to do with the underlying fundamentals of the most basic of economic laws—supply and demand. There is still a higher demand for homes than there is supply, which is good news for sellers.

How Will the Rise in Fed Interest Rates Impact My Current Mortgage?

Will Fed rate hikes change your current mortgage? It depends on what type of mortgage you have. We’ll explore different types of home loans below to determine if the Fed rate hikes will affect how much you pay each month.

Finding a Quality Realtor

Whether you plan on buying or selling a home, the most important thing is to find a reputable and quality real estate agent. Real estate agents can also recommend lenders to help you with the process of securing your mortgage.

Under the Real Estate Settlement Procedures Act (RESPA), realtors are prohibited from receiving money in recommending a preferred lender. Your real estate agent will often recommend a lender for your mortgage because they trust them and know they are reputable. Whether you agree to the terms of a fixed or ARM mortgage from your realtor’s preferred lender or your own is completely up to you.

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