Well, here we are. It took longer than expected, but mortgage rates have finally made a decent recovery after nearly three years of increases.
Prices fell below year-ago levels a week or two ago, according to Freddie Mac, and took another big plunge after Friday’s weaker-than-expected jobs report.
As for why, low hiring, high unemployment, and slow wage growth all point to a slowing economy. Interest rates also tend to fall when the economy cools.
Moreover, the Federal Reserve is expected to make its decision and start cutting interest rates, which could serve as another impetus for lower mortgage rates.
This has led many to believe that we will see another surge in demand for homes, and perhaps a significant increase in home prices. But is this true?
Do low interest rates actually increase home prices?
It seems perfectly logical on the surface. If something people want becomes cheaper overnight, demand for it should increase.
If demand increases, the price may rise as supply decreases, especially if there are already very few homes for sale.
But if this is true for single-family homes, why haven’t asking prices declined over the past year and changed?
After all, 30-year fixed mortgage rates nearly doubled from their record lows in the mid-2000s into early 2021 before peaking at more than 8% last fall.
Using the same logic above, home prices would almost certainly fall sharply as buyers flee the market, leading to a massive oversupply.
Instead, the pace of home price increases has slowed, and home prices have continued to rise in most parts of the country.
In fact, if we look at many housing price indices, we see new home prices hitting all-time highs almost every month.
Home prices continued to rise as mortgage rates nearly tripled.
Just take this chart from the Federal Housing Finance Agency (Federal Mortgage Finance Fund), which oversees Fannie Mae and Freddie Mac.
The latest report, released on July 30, found that home prices rose 5.7% from May 2023 to May 2024.
However, house prices have been flat on a monthly basis since April after rising 0.3% the previous month.
However, if you look at the chart, you’ll see that home prices haven’t slowed much as mortgage rates started to rise in early 2022.
There was a brief pause as the housing market absorbed the nearly three-fold increase in interest rates, but then prices continued to rise relentlessly.
If we want to say that there is an inverse relationship between rates and prices, the last few years are not a good example of that.
All we’ve really seen is a positive relationship between rates and prices, with both rising together.
Now that mortgage rates are poised to rise a bit, should we just ignore that and say the relationship is negative?
Can we say that prices should have fallen when prices rose, but now that prices have fallen they should rise even more?
There may not be much of a connection at all.
Instead of trying to invent a relationship between mortgage rates and home prices, perhaps we should accept the fact that there is no strong relationship between the two.
There’s no mistaking that. If you look at history, you’ll find that changes in mortgage rates and home prices are not closely related, according to a report from the International Finance Corporation. Urban Institute.
I’ve posted this chart before, but here it is again if you don’t believe it. You’ll see all sorts of combinations of annual mortgage rates and home price changes.
These small points will not make it easy to prove that lower mortgage rates lead to higher home prices, or vice versa.
Instead, you’ll see instances when they rose together, fell together, or sometimes, to fit the popular narrative that’s not necessarily true, went in opposite directions.
Of course, nominal (not inflation-adjusted) house prices rarely fall to begin with, so we don’t have many examples to look at.
Why do house prices fall if mortgage rates become cheaper?
Well, just look at the economy… Sure, mortgage rates matter because they can have a big impact on affordability.
The lower the price, the more affordable the home buyer is, all else being equal. In fact, a 1% drop in mortgage rates equates to an 11% drop in price.
But this simplistic view ignores cash buyers, and also ignores the financial health of potential home buyers who need to get mortgage approval.
Just consider the past few days. The stock market has been hammered, with the Dow Jones down more than a thousand points today and the Nasdaq down nearly 600 points.
The sell-off was sparked by concerns about the health of the economy, with weaker data expected to lead to interest rate cuts by the Federal Reserve.
It is very likely that the softer data will be accompanied by lower mortgage rates as well.
Simply put, signs of a slowing economy have improved the odds of a Fed rate cut and given a boost to bonds, which are a safe haven for investors when times get tough.
But if households are worse off because of this data, there will be fewer home buyers. There may also be more sellers, perhaps even defaulters.
taken together, We may face a situation where the supply of homes for sale is high and prices are falling, despite a significant improvement in mortgage rates..
So yes, home prices may actually fall, even if mortgage rates fall!
But this is not a foregone conclusion, and is likely to be highly variable based on the economic strength and individual market dynamics across countries.
The main message here is that there is no strong correlation in any way. To think otherwise may simply lead to disappointment.
Prior to creating this site, I worked as an account manager for a wholesale mortgage lender in Los Angeles. My experience working in the early 2000s inspired me to start writing about mortgages 18 years ago to help potential (and current) home buyers better navigate the home loan process. Follow me on Twitter for the latest news.
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