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HIGH MORTGAGE RATES SHOULD LOWER PRICES. SO WHY AREN'T THEY? In the world of residential real estate, decisions are often based on market data that can be both conflicting and confusing. Understanding the dynamics of mortgage rates and home prices is essential for making informed decisions. Despite high mortgage rates, which theoretically should lower home prices by making buying more expensive, prices continue to rise. Here's a closer look at why this is happening. THE NUMBERS According to Freddie Mac, the average rate on a 30-year fixed-rate mortgage has been around 7% since February, peaking at 7.22% in early May and settling just below 7% in July. These rates are significantly higher than the sub-3% rates seen in 2021. Concurrently, home prices have been climbing. The National Association of Realtors reported that the median price of an existing home in the U.S. was $419,300 in May, up nearly 6% from the previous year. The S&P CoreLogic-Case Shiller Index also showed a 6.3% increase in April. In many markets, home prices have hit record highs this summer. Higher mortgage rates undoubtedly make buying a home more expensive. For example, in July 2021, when rates averaged 2.88%, the monthly payment on a $400,000 home was about $2,000. At a 7% interest rate, the same home now costs nearly $3,000 per month. Despite these higher costs, home prices continue to rise. Why?  THE EXPLANATION Intuitively, one might expect that higher mortgage rates would lead to lower home prices, as potential buyers get priced out. However, the relationship between mortgage rates and home prices is complex. Historically, there have been periods when both rates and prices fell (1991, 2008-2011) and times when low rates coincided with rising prices (2003, 2012). From 1988 to 2024, the correlation between average mortgage rates and home price appreciation is weakly negative (-0.12). Since 2021, we have seen both mortgage rates and home prices generally rise. Despite expectations that this would slow price growth or cause declines, several factors are keeping prices elevated: Housing Equity Gains: U.S. mortgage holders saw near-record levels of home equity in early 2024. Nearly 40% of U.S. homeowners own their homes outright, without a mortgage. Repeat buyers can leverage this equity for new purchases, effectively buying down their mortgage rate and making them less sensitive to rate increases. Low Supply: Although inventory has increased recently, overall supply remains low. Nationally, there was just 3.7 months of supply at the end of May, with some local markets having even less. Tight inventory puts upward pressure on prices. Strong Financial Health: The labor market remains strong, unemployment is low, and wages are rising. While consumer confidence has dipped slightly, many Americans still feel positive about their finances. This optimism supports continued spending, including on homes. Interestingly, home prices might begin to decline as mortgage rates start to fall. More supply and reduced personal savings are expected to slow price appreciation in the latter half of the year. While major price corrections are unlikely, and affordability will remain a challenge, lower rates and slower price growth will provide some relief for homebuyers. Understanding why home prices are rising despite high mortgage rates involves looking beyond borrowing costs to factors like housing equity, supply constraints, and the financial health of households. While the current market presents challenges, it also offers insights into the resilience of home prices and the multifaceted nature of real estate dynamics.
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