How will rising rates affect home prices? How high will rates go?

[Brandon T.]

Hey BP members,

I'm confused about a topic and I'm hoping someone could help me and possibly others understand. I have a couple questions:

1)

I know that when inflation increases it causes home prices to increase as well.

I also know that when inflation increases, the fed has to increase interest rates to combat that inflation which causes home prices to fall.

So my question is, in our environment now where inflation is increasing as well as interest rates (soon), will home prices continue to increase or fall over the next couple years? Inflation is still going up, so that should make home prices go up. Rates are also going up which should make home prices fall.

Given that there's such low supply on the market right now is it possible that rate hikes won't affect housing prices?

2) 

How high could mortgage rates potentially go? 2% more, 5% more, 10% more? Over the next decade or so.

Could rates rise 1-2% before fixing the inflation issue and come back down? Or could they continue to rise such as back in the 1970s? Is it even possible to know for sure?

Thanks for any thoughts and ideas.

[Russell Brazil]

Quote from @Brandon T.:

Hey BP members,

I'm confused about a topic and I'm hoping someone could help me and possibly others understand. I have a couple questions:

1)

I know that when inflation increases it causes home prices to increase as well.

I also know that when inflation increases, the fed has to increase interest rates to combat that inflation which causes home prices to fall.

So my question is, in our environment now where inflation is increasing as well as interest rates (soon), will home prices continue to increase or fall over the next couple years? Inflation is still going up, so that should make home prices go up. Rates are also going up which should make home prices fall.

Given that there's such low supply on the market right now is it possible that rate hikes won't affect housing prices?

2) 

How high could mortgage rates potentially go? 2% more, 5% more, 10% more? Over the next decade or so.

Could rates rise 1-2% before fixing the inflation issue and come back down? Or could they continue to rise such as back in the 1970s? Is it even possible to know for sure?

Thanks for any thoughts and ideas.

Rates are driven by prices. Rates do not drive prices. Most people get the correlation backwards.

Not once in the entire history of modern economics has a rising interest rate environment correlated to a falling price environment. 

The tail doesnt wag the dog. The dog wags the tail.

[JD Martin]

Well, there's no way to know for sure. It's virtually inconceivable rates will go anywhere near the 15-18% they hit in the early 80's since it would destroy the economy (housing is a much bigger part of the economy than it was 40 years ago). On my first mortgage I paid almost 9%. That was in the early 1990s. I could theoretically see mortgage rates getting back as high as 6-7% before there started to be some real serious pain. 

As for rates and housing prices, yes it will definitely affect it. Even with low supply, high rates can destroy demand, which would just bring supply & demand back into equilibrium or swing the pendulum the other way. It's not as if home buyers have no other options - they can rent, cohabitate, live with parents, or not move from their current home. There may just end up being more of that. 

Most people can't buy a home for cash, so lending requirements are always going to be a huge factor in home prices for the masses (I'm excluding super-rich stuff). If a minimum down payment is 10%, and interest rates climb by a couple of percent, the maximum loan an individual qualifies for will be reduced, so they would have to make up the difference in cash, something most home buyers lack. Say a person qualifies for a $200k home based on their income, and they have to put down $20k and mortgage $180k. If rates climb by 2%, their maximum qualification is going to fall to perhaps borrowing $150k, so they would need $50k to buy that same $200k home (25% down). They'll either be pushed into a lower purchasing pool or out of the market altogether. This has happened to several of my tenants who were hoping to become homeowners. The home price increases have happened so rapidly that they can't make up the difference to get qualified. If rates go up and prices come down, they're still in the same boat. 

[Brandon T.]

Originally posted by @Russell Brazil:

Quote from @Brandon T.:

Hey BP members,

I'm confused about a topic and I'm hoping someone could help me and possibly others understand. I have a couple questions:

1)

I know that when inflation increases it causes home prices to increase as well.

I also know that when inflation increases, the fed has to increase interest rates to combat that inflation which causes home prices to fall.

So my question is, in our environment now where inflation is increasing as well as interest rates (soon), will home prices continue to increase or fall over the next couple years? Inflation is still going up, so that should make home prices go up. Rates are also going up which should make home prices fall.

Given that there's such low supply on the market right now is it possible that rate hikes won't affect housing prices?

2) 

How high could mortgage rates potentially go? 2% more, 5% more, 10% more? Over the next decade or so.

Could rates rise 1-2% before fixing the inflation issue and come back down? Or could they continue to rise such as back in the 1970s? Is it even possible to know for sure?

Thanks for any thoughts and ideas.

Rates are driven by prices. Rates do not drive prices. Most people get the correlation backwards.

Not once in the entire history of modern economics has a rising interest rate environment correlated to a falling price environment. 

The tail doesnt wag the dog. The dog wags the tail.

Thanks for the distinction Russell that helps a lot, I appreciate your reply.

[Brandon T.]

Originally posted by @JD Martin:

Well, there's no way to know for sure. It's virtually inconceivable rates will go anywhere near the 15-18% they hit in the early 80's since it would destroy the economy (housing is a much bigger part of the economy than it was 40 years ago). On my first mortgage I paid almost 9%. That was in the early 1990s. I could theoretically see mortgage rates getting back as high as 6-7% before there started to be some real serious pain. 

As for rates and housing prices, yes it will definitely affect it. Even with low supply, high rates can destroy demand, which would just bring supply & demand back into equilibrium or swing the pendulum the other way. It's not as if home buyers have no other options - they can rent, cohabitate, live with parents, or not move from their current home. There may just end up being more of that. 

Most people can't buy a home for cash, so lending requirements are always going to be a huge factor in home prices for the masses (I'm excluding super-rich stuff). If a minimum down payment is 10%, and interest rates climb by a couple of percent, the maximum loan an individual qualifies for will be reduced, so they would have to make up the difference in cash, something most home buyers lack. Say a person qualifies for a $200k home based on their income, and they have to put down $20k and mortgage $180k. If rates climb by 2%, their maximum qualification is going to fall to perhaps borrowing $150k, so they would need $50k to buy that same $200k home (25% down). They'll either be pushed into a lower purchasing pool or out of the market altogether. This has happened to several of my tenants who were hoping to become homeowners. The home price increases have happened so rapidly that they can't make up the difference to get qualified. If rates go up and prices come down, they're still in the same boat. 

 Thanks for the perspective JD. That's a great point and a great example and it'll be interesting to see how this all plays out. I feel good about buying deals that cash flow right now because of the low rates and price swings ultimately don't matter too much for my specific goals. It's interesting a lot of people are still buying heavily in hot markets with little cash flows, it seems really risky if prices were to correct at all for any reason.