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How interest rates and economic factors impact housing

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The housing market is complex. Prices are driven by a wide variety of factors that are local, regional, national and global. While basic concepts like supply and demand come into play, other things like mortgage rates, inflation, and even economic conditions in other countries all influence the housing market.

We’ll break down how various factors impact the cost of housing.

The federal funds rate and the 10-year bond rate

The federal funds rate is a benchmark interest rate that is determined by the United States Federal Reserve. This rate is the interest rate that banks charge when lending each other money overnight.

This rate is called a benchmark rate because it winds up serving as a benchmark for many other interest rates. Everything from savings accounts to credit cards set interest rates in part based on changes in the federal funds rate.

Bonds, such as the US government 10-year bond, also have interest rates that are influenced by the federal funds rate.

Historically, the interest rate on 30-year mortgages have moved in tandem with changes in the 10-year Treasury bond rate. As the 10-year bond rate sees rate increases, mortgage rates rise. The same is true for rate decreases.

Higher interest rates mean higher monthly payments for mortgages, which can make it harder for many people to buy a home.

Inflation and housing

Inflation is the process through which money loses purchasing power. For example, inflation in the past year was 8.5 percent, so something that cost $100 a year ago would cost $108.50 now.

Inflation impacts the housing market in a few ways.

For one, inflation causes the prices of homes to rise just as it causes the price of all goods to increase.

However, one of the Fed’s goals is to try to control inflation and keep it at a steady, low rate. If inflation rises significantly, the Fed might increase the federal funds rate to reduce the money supply and reduce the inflation rate.

This increase in the federal funds rate can cause mortgage rates to rise and rising mortgage rates can decrease home buying demand, leading to a fall in home prices.

Current interest rates

Current mortgage interest rates, which are impacted by the federal funds rate and other market rates, influence the price of housing.

When rates rise, that leads to an increase in the monthly payment for a loan of the same amount. For example, at a 4 percent interest rate, a $250,000 mortgage would cost $1,194 per month. At 6 percent interest, the same loan would cost $1,439. The effects are even greater for larger loans.

According to Allyson Waddell, an agent success manager at RealtyHop, a nationwide housing website, recent increases in rates have had a big impact on purchasing power. “With mortgage interest rates around 6 percent, American homebuyers have 24 percent less spending power than they did a year ago.”

As rates rise, people can’t afford more expensive homes, which can kill demand and drive down prices.

Housing inventory and new construction

Supply and demand are two simple factors that influence the price of all goods and services. If more people want a thing, prices rise. If more of that thing becomes available, prices fall.

Housing inventory can be impacted by many factors. New construction is pretty much the only way to add more supply to the housing market. However, new construction can be slowed by rising labor and materials costs. Rising interest rates and falling home prices also slow down construction, which limits supply increases in the housing market.

“Housing construction is not increasing at the level needed to combat the shortage,” says Waddell. “Interest rates could remain at this level for a while, and a buyer will not see a benefit to waiting to purchase a property solely to wait for a decreased rate.”

Politics can also play a role in housing construction, with zoning restricting the construction of things like apartments that can create additional housing supply. In recent years, large investors have bought up properties to turn them into rentals, further constricting the supply of homes for people to buy.

It’s rare for housing markets to experience significant increases in supply. Population growth and other factors naturally lead to larger increases in demand than supply.

Local housing market factors

Local factors impact housing prices in many ways, generally by influencing the demand for homes.

For example, if a major employer in the area shuts down and many people lose their jobs, that can reduce demand for housing and cause prices to fall. Other factors, like the quality of the school district, pleasant weather, and proximity to things like major cities or amenities can drive up demand.

The level of supply and demand in a local area greatly impacts the prices in that area. It also influences whether buyers or sellers have more negotiating power.

For example, Seth Bellas, Producing Branch Manager at Churchill Mortgage, has noted that decreased demand from buyers has made sellers more willing to negotiate.

“Higher rates do put a strain on lower-middle class borrowers because of the higher payments, but the slowdown has also made it possible in some cases for those same buyers to get closing costs covered and get offers accepted with the contingency of selling their current home. We have also seen an uptick in VA and FHA offers being accepted, whereas in the more competitive environment, these offers were often snubbed by sellers,” he says.

Given current conditions, what’s next?

Predicting the future of the real estate market is difficult even for the experts. No one really knows how things are going to change in the future.

One the one hand, interest rates have risen significantly in recent months and the Fed has not done anything to make it seem like it plans to slow down. However, housing prices have spiked in the past few years,  increasing by more than 30 percent since 2020.

Some believe that rising rates and an economic slowdown will force prices to fall. Others insist that inflation and reduced housing supply caused by a slowdown in new construction and institutional investors buying inventory will lead to prices holding steady or continuing to rise.

Find a trusted real estate agent

No matter what happens to the real estate market over the next months and years, if you’re thinking about buying or selling a home, it’s a good idea to work with a knowledgeable real estate agent. A good agent can give you insight into your local market and determine a fair price for properties in your area.

Written by
TJ Porter
Contributing writer
TJ Porter is a contributing writer for Bankrate. TJ writes about a range of subjects, from budgeting tips to bank account reviews.
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