The Impacts of Rising Interest Rates on Real Estate in 2022
Average mortgage rates are now above 6%. Only a few months ago, in late 2021, I had a few clients who were able to secure 30-year fixed mortgages at under 3% interest rates. Although a 3% increase may not seem like much, consider that this 3% increase means that interest rates have doubled in just about six months.
So, how does the rise in interest rates impact the real estate market?
Let's first consider the impact on buyers. Every increase in interest rates represents a much more significant reduction in purchasing power. If your budget was $1M for your new home and interest rates rise, you may find the increase in monthly interest paid over the course of your mortgage now reduces the budget you can put towards the home significantly because the interest rate increase carries through to your payments. A simple 1% increase in rates could mean as much as 10% or even larger increase in your monthly mortgage payments. If you think about the interest rate impact on housing prices, you can also see that the low-rate environment we have been in for so long was a significant contributor to fueling the housing market boom over the past few years.
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How Rising Interest Rates Impact Sellers
On the seller side, accepting financed offers may be less enticing in a higher-rate environment. As the seller, if you know the buyer will need, you may worry the details of the loan will negatively impact closing the deal. A financing complication may leave you without a buyer and forced to put the property back on the market. As a seller, you might also find your home is worth less, given that the number of buyers may be shrinking as more and more people are priced out of the market – even if solely due to the cost of financing.
For example, I have a client who sold their home just before the spring of 2022. They received a great offer on their home and were moving through the closing process as quickly as possible. The buyer was looking for financing, and just in the time it took them to close, the interest rates changed. These changes not only affected the buyer's finances but also spooked them about the housing market in general. As a seller, it is essential to understand how rising rates may impact your sale price and closing process.
What Happens When Interest Rates Increase
We also see much less real estate activity in general due to higher interest rates. (Fewer buyers and sellers overall, as they don't want to sell a home currently financed at 3% to move to another where they will have to pay 6% in interest.) When interest rates are low, financing and leveraging debt can help an investor significantly. In times of cheap money (low-interest rates the cash flow or prospects for growth in any given investment don't have to be as attractive because the carrying costs are much less. When interest rates rise, we find less speculation and, therefore, less activity in the housing markets as real estate investments are looked at much more stringently by investors, with only the best deals taking place.
That said, as the effects of rising rates begin to permeate, it can often lead to higher rent demand, which may also help investors of rental properties. It takes time for these effects to work their way through the system and increase rental demand. However, often it can lead to stronger income from rental properties if the rise in rates is large enough to reduce the number of buyers in the market, therefore increasing the demand from renters.
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As long as wages continue to increase, rising rates may not have a significant impact on real estate. However, when interest rates rise, and economic growth slows, we start seeing significant impacts on real estate markets. Undoubtedly, we have begun to see these impacts already, and if rates continue to climb higher, the effects will be more clear.
If you have concerns about these impacts on your finances, a financial advisor can help you determine how to adjust your home purchasing or real estate investment strategies as interest rates fluctuate. At the very least, understanding the relationship between interest rates and real estate prices will help you analyze the role of real estate in your finances moving forward. Let us know if we can help you with this analysis by getting in touch with us today.