Interest rates remain low by historical standards but are eventually rising slightly.
The 10-year Treasury was yielding around 1.2% as recently as August. It is now over 1.8%.
The move is a blip on any long-term interest rate chart, but on a relative basis, bonds are selling as yields rise here.
There are a lot of variables that go into the movement of interest rates but it is quite clear that the Fed is a big reason why rates are ultimately going up.
Now expect the Fed to raise short-term interest rates four times this year. Going from 0% to 1% in a world with 7% inflation certainly doesn’t sound like the end of the world, but the Fed is putting psychological pressure on the markets in many ways.
In addition, there is a good chance that lending rates will rise elsewhere.
In fact, we’re already seeing this with mortgage rates. The 30-year fixed rate stood at around 2.8% in August. It is now closer to 3.5%. Still low by historical standards, but if these rates keep rising, there could be some pressure on home buyers.
But not in the way you would believe.
The last Fed rate hike cycle from 2015 to 2018 saw mortgage rates rise, from 3.6% in early 2015 all the way to 5% in November 2018:
This is a big move.
On a $350k mortgage, that’s an additional $285 per month in payments, going from 3.6% to 5%. That doesn’t bode well for future homeowners.
Finance theory would also tell us that higher interest rates should lead to a drop in home prices. If you raise the discount rate, all else being equal, the value of the financial asset should go down. And it makes sense in theory.
Unfortunately, everything else is rarely equal and the housing market doesn’t care that much about financial theory.
From 2015-2018, housing prices rose about 23% nationally (according to the Case Schiller National Home Price Index).
Now you could say that this is simply because prices were still recovering from the 2012 housing crash. We must put these numbers in context.
But this was not the first time that housing prices have risen at the same rate as mortgage rates. In fact, in every prolonged rising rate environment I’ve seen over the past 50 years, when mortgage rates went up, so did housing prices.
Some thoughts on this data:
I still can’t believe how high the borrowing rate was in the 1970s, 80s and 90s. Investors panic these days when we go from 1.2% to 1.5% on 10 years.
How does the economy function with lending rates in the double digits? Can you imagine buying a house with an 18% mortgage rate in 1981?
It really makes sense that when mortgage rates rise, housing prices go up.
Redfin conducted a survey earlier this month that asked potential homebuyers how they would react if mortgage rates rose above 3.5%:
Nearly half of those surveyed claimed it would increase the urgency to go in and buy. It doesn’t make sense at face value when you consider higher borrowing costs to mean higher monthly payments.
But if you see a rise in prices while rates are going down, it may bother you that rates will continue to rise as rates go up. And homeowners are less likely to sell in the face of rising rates if they already have a low mortgage rate that is locked on their home.
So you get this scenario where buyers are quick to pull the trigger while sellers can pull back the supply of homes for sale. And when supply is already as low as it once was, it won’t take long to create a supply-demand imbalance:
Another reason why housing prices take away from financial theory when it comes to rising interest rates is that home buying is the most emotional of all property purchases.
Emotions are a part of every market on earth because markets are created by humans. It is impossible for us to leave human nature at the door.
While fear, greed and jealousy can be ruled by stocks, bonds and crypto, the housing market acts on a variety of emotions.
People buy homes because they want to settle down. They buy because of the stage they are in in life. They buy for jobs or family or community or schools or location and dozens of other reasons that come into play before lending rates enter the equation.
It’s certainly possible that this timing could be different because housing prices are on such a hot streak.
But I would not bet my life on this.
Millennials are the largest demographic in the United States. They are in their prime homebuilding years.
Higher mortgage rates may slow the rise in housing prices, but I doubt they will cause prices to drop dramatically because supply is so short and there are so many willing buyers.
Further reading:
Is the U.S. Housing prices not getting affordable?
