Will Home Prices Decrease When Mortgage Rates Increase?

As we are currently experiencing rock-bottom mortgage rates under 3% for a 30-year fixed mortgage, it’s only natural to wonder what will happen to home prices when interest rates finally increase again. This is particularly important for first-time homebuyers who are planning to buy a house in the near future but still have to wait a couple years, like myself. With rates so low and a scarcity of houses on the market, house prices have soared. This has been especially true during the Covid-19 pandemic, as people stuck at home realize that they need more space and the increased ability to work at home means more people are able to move to the suburbs. The low mortgage rates have allowed people to buy more expensive homes since the monthly payments would still be manageable. However, when the economy eventually recovers and mortgage rates rise, current home prices would become unaffordable to many. Surely home prices would fall if mortgage rates rise so consumers are still able to purchases homes, right?

To answer this question, I used national median home price and inflation-adjusted home price data for sales of existing homes compiled and calculated by DQYDJ and average national mortgage rate data compiled by Freddie Mac. This data stretches from April 1971 to June 2020. You can see the data plotted against each other in the graph below.

Home prices plotted against 30-year fixed mortgage rates from April 1971 to June 2020

Is there a correlation between mortgage rates and home prices?

Overall, mortgage rates have been falling since 1981, and home prices have been rising steadily except for the period beginning during the Great Recession of 2007-2009 and continuing until 2011. Inflation-adjusted home prices have increased more slowly, and there have been several periods with modest declines in addition to the large decline during the Great Recession. On first glance, there does not appear to be any correlation between mortgage rates and home prices aside from the overall trends. Periods that deviated from the overall trends saw no consistent deviation in the other variable. Let’s look closer to make sure we’re not missing anything.

What happens to home prices when mortgage rates increase?

There is only one period when mortgage rates increased for an extended time: 1971 to a huge peak in October 1981. Due to rampant inflation, the chairman of the Federal Reserve, Paul Volcker, raised the federal funds rate to as high as 20%, which caused mortgage rates to rise to similarly high levels. Although this helped to address the inflation issue, it was also partially responsible for the 1980-1982 recession. Here’s what the period of increasing mortgage rates looks like in greater detail:

Home prices plotted against 30-year fixed mortgage rates from April 1971 to November 1981

As you can see, mortgage rates increased throughout the period, at first gradually, but then more drastically, rising from about 8% to more than 18%. During these 10 years of mortgage rate increases, the median home price never decreased. It even began to increase a little faster when mortgage rates started to rise more steeply. On the other hand, inflation-adjusted home prices did decrease for the first couple years and again when mortgage rates rose rapidly. This is to be expected, as the goal of raising mortgage rates was to combat inflation. However, from about 1975 to 1979, even the inflation-adjusted home prices grew. This all suggests that home prices do not decrease when mortgage rates increase, especially if you’re not considering inflation, which few consumers do.

What happens to mortgage rates when home prices fall?

As I mentioned before, there was only one period when home prices decreased: from 2007 to 2011 (during the Great Recession), as you can see below.

Home prices plotted against 30-year fixed mortgage rates from January 2006 to June 2012

During this period, both median home prices and inflation-adjusted home prices fell, and mortgage rates similarly declined. This is unsurprising, as the Fed would not want to increase interest rates during a recession, which could make the economy worse. Since both home prices and mortgage rates decreased, there is again no evidence for increasing mortgage rates being correlated with decreasing home prices.

Conclusion

Unfortunately for me, there does not appear to be any evidence that home prices will decrease when mortgage rates rise. As we have seen, when mortgage rates increased in the past, this was not correlated with decreasing home prices, and decreases in home prices during the Great Recession also did not correlate with increasing mortgage rates. Although mortgage rates are an important factor when buying a home, they apparently do not actually affect home prices (they only affect the amount of interest you pay on your mortgage). It is likely that home prices are more dependent on supply and demand. For those who have already purchased homes, this is good news, since you’ll want your home to keep appreciating in value. As for me, I will just have to hope that mortgage rates remain low for the next few years, which is expected to be the case at least through 2023.

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