The Impact of Interest Rates on the Real Estate Market

Homebuyers and sellers often – and justifiably so – look at the recent central bank rate hikes with a mixture of fear and confusion. On the one hand, news outlets are sounding the alarm with punchy headlines about declining markets. But on the other hand, consumers might reasonably be confused about why rate hikes impact the markets.

This article aims to clear the air. In the spirit of consumer empowerment, let’s track the complicated relationship between interest rates and the real estate market. If you plan on buying or selling a property in 2023, consider this a primer on one of real estate’s most fundamental mechanisms.

Interest Rates 101

Interest rates indicate the amount of money a lender charges a borrower as a percentage of the principal (the amount lent). For instance, in real estate, a lender might charge 3% annual interest on a 200,000 mortgage, in which case the borrower pays that amount monthly (divided by 12) on the outstanding balance of their mortgage. You can find a more detailed breakdown of how interest rates work in the article linked here

While it might be advantageous for lenders to “race to the bottom” in a bid to attract borrowers, they do not have the final say on how little they can charge on interest. Central banks do. To central banks, interest rates are an important tool for guiding monetary policy. They can lower interest rates for a short-run boost to the economy. And by contrast, they can implement rate hikes to curb inflation.

What Influences a Homebuyer’s Interest Rates

The central bank sets the target for the overnight rate to enact a monetary policy. However, that rate isn’t the only factor influencing your mortgage interest rate. Banks use this to pinpoint the range of APRs (annual percentage rates) they offer, but they also take into account several other considerations.

Downward pressure from market conditions can affect rates; bond markets can affect rates; and, like all loan products, your personal credit and repayment risk influences your mortgage rate. If you’re interested in calculating and comparing mortgage rates or speaking to a professional, visit Nobul, an end-to-end real estate platform created by innovator Regan McGee. It’s a terrific resource for consumers looking to navigate through tumultuous times.

Knock-on Effects: Rate Hikes and the Real Estate Market

You might still be curious: what’s the connection between mortgage rates and the real estate market? To answer this question, we can look at the last three years as an illustrative case study.

Amid the later phases of the pandemic, central banks were interested in stimulating the economy. Several industries suffered setbacks, and the prevailing wisdom was that we should have a monetary policy that spurred spending. So, central banks set interest rates at a near-record low. These low rates caused many prospective homebuyers (and even some real estate “agnostics”) to enter the market, capitalizing on lower monthly payments. As expected, this demand frenzy created a roaring seller’s market – when demand far outpaces supplies and prices shoot up.

At around this time, several younger-generation consumers (mainly millennials, but also some Gen-Yers) entered the real estate market. They had built up their down payments over a relatively quiet period of spending over the pandemic. They were focused on improving their living situation (as many people were after months of “quarantining” indoors). And they saw the low interest rates as their time to strike. These new market entrants added fuel to the proverbial fire, furthering the seller’s market frenzy.

Then – as everything must – it all came back down to earth. With inflation threats looming, the central bank reversed its position. It needed to cool things off a bit, and so it hiked rates. And then it hiked rates some more. Suddenly, a prospective homebuyer looking for a mortgage could expect to pay far higher than their peers did a couple of years back. The macro effect here is that fewer people took out mortgages; fewer people bought homes; the housing market cooled; supply started to catch up with demand; home prices lowered in most places.

No one knows what the central banks’ next moves will be. Will they level out their rates? Will they hike rates? Or will they start the slow, cautious march toward lowering the rates once again? As demonstrated, the answers to these questions will impact the real estate market. Curious consumers considering buying or selling are encouraged to do further research at the links provided.