With the expectation that the Federal Reserve is on the cusp of raising interest rates, we’re hearing all sorts of predictions about how this will affect the red-hot U.S. housing market, which just registered record-high increases for 2021. Though analysts differ on just how many times the Fed will increase rates — much less how high — the impact on mortgage rates when it does act is a given.
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What’s less clear, though, is whether rising rates will undermine the housing market by raising the cost of borrowing. On the face of it, they should. The higher the rate, the bigger the monthly payment — and the less potential homebuyers can afford. Housing prices consequently decline.
There’s a seductive appeal to this argument. In the case of the relationship between interest rates and home prices, though, the old warning on medieval maps holds: Here be dragons. Disentangling the many variables in play in this dynamic should give us pause about predicting the future direction of the housing market.
The literature on the relationship between interest rates and home prices is extensive, complicated and contradictory. There’s a general consensus that cutting rates close to zero can help fuel a housing bubble, but the precise mechanisms and timing of how that plays out is still not fully understood. Nor is it entirely well-established what happens when the Fed — or for that matter, other central banks — hike rates.
Consider, for example, the run-up to the financial crisis in 2008, when house prices went through the roof before crashing. Many accounts of that calamity find some version of original sin in the Fed’s decision to slash rates in the wake of the tech bubble’s collapse in 2000 and the 9/11 terrorist attacks, from a high of approximately 6.6% in 2000 to a low of 2% by 2003. Mortgage rates followed, and everyone piled into the housing market — or so the theory goes.
Read the full article here by Stephen Mihm, Advisor Perspectives
