Rising Interest Rates and the Real Estate Market

By Brad Greiner, CEO of OpenAiRE Brokerage and Open Air Homes


In 2020, Covid-19 triggered one of the worst global economic recessions since the Second World War, with a 5.2% shrinkage. Moreover, it was the deepest recession in recent years, with a large fraction of economies experiencing steep declines in per capita output. As a result, many central banks slashed interest rates to boost liquidity and stimulate economic growth.

The COVID-19 pandemic caused business closures, layoffs, work-from-home policies, and event cancellations, triggering a deep economic downturn. As a result, in March 2020, the Federal Reserve slashed interest rates to zero and planned to buy at least $700 billion in mortgage-related and government bonds.

The move was part of a nationwide emergency action to insulate the economy from the COVID-19 pandemic impact. The Federal Reserve also started lending to support households, financial market participants, state and local governments, and employers.

It was the most dramatic move by the bank since the 2008 financial crisis. The aim was to keep financial markets stable by lowering borrowing costs as much as possible as the US economy hurtled towards recession.

Why Interest Rates are Rising in 2022

By January 2022, interest rates had started rising considerably, jumping 57 basis points since the previous year. The rise saw an average rate on a 30-year loan settle at 3.22%, the highest increase since May 2020, when the Federal Reserve cut mortgage interest rates to zero.

The Federal Reserve also pulled back on purchasing mortgage-backed securities, and a flurry of hikes in the federal funds rate did not help matters.

By March 2022, the Fed had raised interest rates again, causing them to jump to five percent from the 3.22% at the start of the year. It was the highest rise in mortgage interest rates since 2011. But the Fed wanted to take some air out of the market and the economy in general.

The rise meant that a buyer would spend $500 more monthly on a $500,000 home than at the start of the year – assuming a fixed-rate mortgage with at least a 20% down payment. This increment comes hot on the heels of an over 30% rise in property prices since 2020.

Homebuyers are becoming exhausted by the cutthroat competition and declining affordability. This turn of events has caused the gravity-defying housing market to ease up. As a result, online searches for properties have dropped, open houses have thinned, homebuilders are exhausting their waiting lists to sell homes, and cancellations have increased.

After two years of pandemic home purchases and torrid demand, real estate agents were accustomed to fielding multiple home offers for their listings and setting price records weekly. That frenzy is now subsiding. It was caused by COVID-19 pandemic migrations and the realization that a home was a necessity.

However, buyers will still find the market plenty competitive despite the decreasing rise in property prices seen in the last two years. Many homes are still selling within a week of listing, with no significant price declines.

By any standard prevailing before 2020, the current real estate market would still be hot and crazed. Home prices remain high with little sign of falling any time soon. Many economists even predict a continued rise throughout 2022.

Why is Real Estate Demand still High?

The pre-pandemic world was bustling with smoothly functioning supply chains and offices. Thus, a steep rise in mortgage rates coupled with the double-digit price appreciation would have led to a severe drop in demand and falling prices. The trend would have echoed throughout the economy, leading people to hold off on making purchases.

Instead, economists predict a rise in prices throughout the year. The issue is that despite the high demand, the housing supply is so low that even a slowing real estate market cannot create enough inventory to meet the demand. Of course, it doesn’t help that the US has suffered from years of a chronically undersupplied housing market.

The 2008 recession saw a decline in home building that remained low long after recovering from the economy and job market. As a result, the pace of home building is still low today compared to the heights of the mid-2000s.

The Effect of Rising Interest Rates on the Real Estate Market

In a dynamic free market, mortgage lenders compete for home buyers’ attention. The competition drives up or down the average monthly mortgage interest rates.

Due to corrected housing prices, a decreasing surplus of unsold homes, and tighter credit standards, the average interest on fixed mortgages remained low from 2013 to 2021. However, it started to rise to 2022, despite being at a historically low level.

Investors have nothing to fear due to the rising interest rates. However, they need to understand the effect of rising mortgage rates and how it impacts home buying. Here are the basics:

  • Interest rates rise along with economic growth. However, higher interest rates result in higher mortgage loan costs
  • Rising interest rates make homes more expensive, reducing the demand for home buyers
  • The reduced demand also hurts sellers because it forces them to reduce their home prices to attract buyers

However, in a fast-growing economy, rising interest rates have minimal effect on housing prices and property value as long as wages and salaries grow in tandem to beat inflation.

Effect of Rising Interest Rates on Homebuyers

Logically, rising interest rates make purchasing or selling homes more difficult, while decreasing interest rates make them easier. However, from the buyer’s perspective, increased mortgage rates reduce affordability.

If a buyer wants to buy a home worth $400,000 with a four percent rate on a 30-year fixed mortgage, he will pay $1,900 as a monthly mortgage payment. But if he only qualifies for a five percent rate, his monthly payments increase to $2,138. So a one percent interest rate increment results in a $238 increase in mortgage payment or about 13%.

From the above example, the buyer only qualifies for a home worth $355,000 based on his credit qualifications. So that one percent increment in interest rates reduces the buyer’s purchasing power by $45,000. Sometimes, lenders may sweeten the deal by offering the buyer a two percent adjustable interest rate for some years, say five. However, the buyer must pay at least seven percent interest after the fifth year.

Effect of Rising Interest Rates on Sellers

Rising mortgage interest rates also affect sellers, but differently. A seller wants to sell her house to the buyer above for $400,000. Rising interest rates reduce the buyer’s purchasing power to $355,000. The seller has to either refuse the buyer’s offer or lower the price to match his offer.

The seller can still profit from the sale, but the rise in interest rates has diminished the home’s market value by $45,000. Consequently, if interest rates rose sharply, the increment would slam the brakes on the real estate market.

Effect of Rising Interest Rates on Property Value

Property value and home prices directly correlate to prevailing mortgage rates. Hypothetically, increased interest rates reduce property market value and home prices and price out some homebuyers. However, decreasing interest rates means more homebuyers can afford mortgage loans, which increases market demand, competition, prices, and property value.

However, in reality, the health of the economy underlies both scenarios. Therefore, rising mortgage interest rates may not significantly affect home pricing and property value when the economy grows fast enough. In addition, a strong economy allows employers to hire more employees and increase salaries to help compensate for inflation and the rising interest rates.

As long as the US economy grows, it will sustain job and wage growth, minimizing the effect of increasing interest rates. Therefore, rising interest rates should not paralyze the real estate market.

Effect of Rising Rates on Real Estate Investing

Increasing mortgage rates can positively affect real estate investing, good news for investors. In addition, demand for the rental properties market will increase because fewer people qualify for mortgages.

Investors should buy real estate properties when interest rates increase because it reduces property prices. Moreover, fewer real estate transactions occur because lending standards are tighter, and the high-interest rates price out most buyers from the market. As a result, more people will seek rental properties until they can afford a mortgage.

A one percent increase in mortgage interest rates can turn into a windfall for investors in the right housing market.

What Rising Interest Rate Means for the Housing Market

Regardless of how much interest rates will rise in 2022, the real estate market and investors will feel the repercussions. These include:

1. Reduces Buyer Demand

The last two years have seen the hottest and most competitive real estate market, primarily driven by low mortgage interest rates. At some point, 30-year mortgage rates reached 2.65%, the lowest since 1971, according to Freddie Mac’s record. It resulted in high-stakes markets with increased buyer competition.

However, rising interest rates will reduce some competition as homes and properties become less affordable and bidding wars reduce considerably. In addition, the reduced competition helps buyers avoid risky bidding tactics like appraisal contingencies or waived inspections.

2. Reduces Refinancing

Low rates resulted in a lot of refinancing in 2021. By the first half of the year, lenders had refinanced $1.6 trillion in loans, representing a 33% jump over the previous year. As a result, lenders were flooded with refinances while homeowners shaved hundreds of their monthly mortgage payments and thousands off their long-term loan costs.

Increased rates reduce the incentive to refinance since even a slight increase can significantly cut down homeowners’ savings, making the refinancing process not worth it. In addition, refinancing comes with fees, closing costs, and a lot of hassle.

3. Slows Down Price Growth

Home prices have grown considerably due to a low inventory and house supply and increased demand. For instance, the national median home price jumped to 19.2 % between 2020 and 2021. The rise in prices was due to pandemic-driven housing demand and bargain-basement rates.

In 2022, the two trends are subsiding, meaning home prices will begin to taper off towards the end of the year. However, home prices will not suddenly drop because demand is still high, driven by Millennials hitting their prime home-buying age. Additionally, supply is still short. Therefore, home prices will continue rising for the foreseeable future.

4. Increase in Rental rates

Rising mortgage interest rates will price out homebuyers and reduce the demand for houses, and the increased cost of homeownership will create more housing pain for renters. In addition, families priced out of homeownership and mortgage loans will increase rental demand and prices.

What It Means for real Estate Investors

Real estate investors ready to buy properties should get into the housing market before interest rates rise further and rental prices increase. One strategy that can help you qualify for a mortgage loan is reducing your budget and looking for properties offering more value and opportunities for discounts.

For example, getting a property 10% below your maximum price allows for a lower purchase price and mortgage loan size and offsets the rising rate environment. Thus, if you are comfortable purchasing a home with a manageable trade-off, such as needing a bit of improvement, you can keep your monthlies low through less debt.

Another way to reduce your mortgage loan is by putting up a hefty down payment. You will borrow less and pay lower interest costs overall. Lenders may also give you a lower rate. For example, if you put down 20% of the asking price, you can eliminate several fees such as monthly mortgage insurance premiums and private mortgage insurance (PMI).

Other benefits real estate investors may enjoy during rising interest rates are:

  • Rising rent prices
  • Higher rental occupancy rates
  • Tax benefits can help balance out the rising interest rates

The Bottom Line

Rising interest rates should not deter real estate investors. Instead, they should adjust their portfolios to take advantage of the market.

Real estate investments outweigh the disadvantages in the cost-benefit analysis above, even when interest rates increase. First, however, the Federal Reserve should take steps to ensure economic growth, prevent stagflation, and keep inflation in check.

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