Now that we are nearing the end of 2022, you may be thinking about what next year will bring in the housing market and how it could affect your decision to purchase a house. There are a number of factors that could affect the real estate market next year. That is why today we will discuss the future of mortgage rates and home prices.
What Is the Relationship Between Mortgage Rates, Inflation, and House Price Growth?
The first thing someone looking to purchase a home today needs to understand is that there has been a positive but modest association between mortgage interest rates and property price increases since 1976. There is a limited correlation between rising mortgage rates and rising property prices. In light of these obstacles, why do we believe that house price appreciation will continue to be so strong? The answer is for the simple reason that times of faster economic growth, higher inflation, lower unemployment, and stronger pay growth have coincided with periods of higher interest rates in general, including mortgage rates.
With that in mind, we must also mention that causation is reciprocal. Since the Federal Reserve has a history of raising interest rates when inflation or growth is more than anticipated, these factors have all been linked to increased property appreciation. We compared people's discretionary spending to house price growth to see how the two are connected. What we found was that there is a greater correlation between inflation and house price growth than between home prices and mortgage interest rates.
Mortgage Rates Will Move in Tandem with Inflation
The market's reaction to rising inflation has been a dramatic increase in mortgage rates this year. A 30-year fixed mortgage rate averaged over 7% at the end of last month, and we've witnessed rapid and significant rises in each of those variables. It's been nearly 20 years since mortgage rates last reached this peak. In fact, a year ago, interest rates were below 3%. This implies that mortgage rates have more than doubled in the last year, albeit they are still lower than in the 1980s.
Never before have mortgage rates doubled in only one year. The future trajectory of mortgage rates is murky at best due to the fact that we are now experiencing unprecedented conditions. Although predicting mortgage rates is not a precise science, most economists believe that rates will continue to fluctuate in response to inflation going ahead. Mortgage rates will undoubtedly rise if inflation remains high. This is the main reason why many people who are considering buying their first home are uncertain about what they should do moving forward.
Rapid Increases in Interest Rates Have Slowed Property Price Growth
The long-term correlation between mortgage rates and home prices does not address the question of what happens to home price appreciation when interest rates suddenly increase. As we've mentioned earlier, mortgage rates in the United States have been on the decline since 1976, with only a handful of periods seeing annualized rate increases of more than 1.5 percentage points. Interest rates rose dramatically from September 1979 to March 1982 and from September 1994 to February 1995. Home price growth jumped by 1.1 percent annually from September 1979 to March 1982. In addition, it rose from September 1994 (2.6%) to February 1995 (3.1%). Inflation-adjusted (or "real") home price appreciation was negative for a part of each time period. In contrast, nominal (unadjusted for inflation) home price increase was never negative outside of economic downturns.
There are several reasons why a healthier economy and more inflation can be good for the housing market. Rising salaries and falling unemployment rates are indicators of economic expansion, which in turn increases demand for homes. Prospective homeowners may anticipate rent increases that are at least as rapid as the inflation rate (or faster if demand is strong). With a mortgage, you may rest easy knowing that your housing expenses will be a set amount each month, regardless of how much rent rises in the future. Further, even though the upfront costs of ownership are greater than the upfront costs of renting, potential buyers may still make the leap since inflation alters the equation. Prospective homeowners prefer the stability of a mortgage payment locked in today to the uncertainty of rent payments in the future.
Variations in Home Prices Depend on the Market
Home prices have cooled down in several regions this year as a result of decreased demand from buyers. This has come as a direct result of increases in mortgage rates. Experts can't agree on the outlook for the next year, however. The agreement is that house price appreciation will be region-specific, with the most dramatic shifts occurring in currently hot markets. According to Strong-Ass Movers, Kentucky and Ohio will most likely have a stable housing market in the coming year. However, the slowing has been more prominent in locations that saw the most significant peak appreciation rates. Price increases may persist in certain locations while decreases occur in others. The supply and demand ratio in that market, among other things, will determine the outcome. This discrepancy in national projections among specialists may explain the graph below.
A Rise in Property Prices Might Be Permanent
As you can probably tell, the future of mortgage rates and home prices is not entirely certain across the board. What higher rates tell us about house price appreciation has been the subject of much conjecture but not much data. We found that significantly higher mortgage rates have a chilling effect on home price growth and may dampen activity in the housing market. To be sure, nominal house price appreciation has been healthy. Moreover, the severe lack of housing stock that we are seeing now was not present during previous times of rapid rises in interest rates, which may help mitigate the current slowdown in house price growth. In summary, rising mortgage rates will have little effect on property prices while sharply decreasing affordability. Instead, difficulties with cost-effectiveness are likely to continue.