How Rising Interest Rates Impact Residential Real Estate: What Buyers and Sellers Need to Know

Let’s do a quick primer on rates. In short, they are most like the relationship status on Facebook that says, “It’s Complicated.” But in simplest terms, with help from Investopedia, here’s a breakdown.

1. Federal Funds Rate: An interest rate set by the Federal Reserve, specifically the FOMC (Federal Open Market Committee) to indirectly manage interest rates, inflation, and unemployment. This is the interest rate commercial banks charge each other to loan to and borrow from each other overnight.
2. Prime Rate: An interest rate that commercial banks charge their most credit-worthy corporate customers. The formula says Prime Interest Rate (aka Prime Lending Rate) = Fed Funds Rate + 3. The WSJ publishes daily the most common Prime Rate. For example, on 5/3/23, The FOMC raised the Fed Funds Rate to 5.25% and the WSJ stated the Prime Rate to be 8.25%. The Prime Rate influences the cost of borrowing for small businesses, lines of credit, car loans, credit cards, and home loans.
3. Interest Rate: A rate that reflects the cost of borrowing by an institution or an individual and reflects the compensation received by the lending agency for forgoing its ability to use that money elsewhere and the risk of not getting it back in part or whole. While the Fed does not set mortgage rates, the cost of borrowing and therefore the supply of funds indirectly impacts mortgage rates.?
4. Mortgage Rate: Adjustable rate mortgages are sensitive to the rate set by the Feds. Fixed-rate mortgages are more closely tied to the yield on 10-year Treasury Bonds.? On a case-by-case basis, mortgage rates are also profoundly moved up or down by an individual’s credit score, property location (can differ by state and urban or rural location), home price, loan amount and down payment amount, loan duration, loan interest rate type (fixed or adjustable rate), loan type (conventional, FHA, VA, USDA), discount points and lender credits. In other words, just because the Fed raised rates, the lender will determine what it costs you to borrow funds to buy a home based on your unique situation at a given time.

Now that we are a bit more familiar with terms let’s take a step back for a broader view. We’ve been here before. Shortly before the beginning of the “Great Recession” in 2008, the Feds raised rates 17 consecutive times, to 5.25%, exactly where we are now after ten consecutive rate raises.

We know that beginning in 2020 with the advent of the pandemic, interest rates dropped to all-time lows, housing inventory was low, new construction suffered because of supply chain bottlenecks, many people were on the move, and as a result, bidding wars became the norm and house prices rose.

By 2021 it was hard for the “average” person to secure a home, and in 2023, now high mortgage rates combined with lingering high home prices have pushed monthly payments up significantly, making lower-priced homes more appealing to the average or first-time home buyer.

Further,? current homeowners holding fixed-rate home loans at a low rate have less incentive to sell, which will keep inventory tight.

As a result, the housing market is gradually moving away from being equally “hot” across the country (and the globe) to localized trends of hot or cooling. In some areas of the country, inventory is still very low, and if investors are buying - or buyers are offering a cash-only deal, homes may still be under contract after multiple offers in a short period of time. Different regions, like here in the South, are still experiencing an influx of people from other parts of the country, so demand is staying fairly strong with only about a two-month inventory supply.

In general, when interest rates rise, the real estate market as a whole is affected in the following ways:

1. Higher Monthly Mortgage Payments: When interest rates increase, as they have ten straight times now, borrowing costs go up, leading to higher monthly mortgage payments for homebuyers. This can make it harder for some buyers to afford a home, reducing demand for homes.
2. Lower Home Prices: Higher mortgage payments can reduce the amount buyers are willing to pay for homes, resulting in lower home prices as sellers need to lower their asking prices to attract buyers.
3. Slower Home Sales: Higher interest rates can make it difficult for some buyers to qualify for mortgages, leading to fewer potential buyers in the market, thus slowing down the pace of home sales.
4. Decreased Refinancing Activity: Rising interest rates can reduce the number of homeowners choosing to refinance their mortgages, reducing the amount of cash available for homeowners to use for home renovations or other purchases.
5. Shift in Demand: Higher interest rates can shift demand from more expensive homes to more affordable ones, as buyers may be less willing to take on larger mortgages. This can lead to increased demand for starter homes or more modestly priced properties. Demand for high-end luxury homes often is untouched by market conditions, however.

Given current conditions, what can buyers or sellers do to help their situation? Well, several factors come into play, including local market conditions, the specific features and amenities of the property, and the needs and preferences of potential buyers.

First, buyers can and should shop around for the best mortgage rates. Even a small difference in interest rates can make a big difference in monthly mortgage payments and the overall cost of the loan.?

Once you’ve found the best rate, take the steps to get pre-approved for a mortgage before home shopping. This way, when you find what you want you can move quickly and be in a better negotiating position.

?Next, buyers should increase their down payment, if possible, to offset the impact of higher interest rates.?

Depending on the locale, sellers may want to price their homes competitively, be more flexible about contingencies, share the closing costs more equitably with buyers, and highlight the home's unique features and benefits - such as updated appliances, energy-efficient upgrades, proximity to schools, shopping, and other amenities, or move-in ready status - that can add value and appeal to potential buyers.?

Finally, work with a real estate agent who understands the current climate and can help buyers or sellers navigate the challenges, streamlining an otherwise complex process of a changing market.?