Economic theory implies that the two should be tightly correlated, but history suggests otherwise
Mortgage interest rates will rise. We can't be sure exactly when rates will begin to climb or by how much, but we know what's coming. Since 2009, other than for a three-month period, average monthly 30-year fixed mortgage interest rates have been at or below 5%. Historically, that's completely unprecedented: average rates had never even hit 5% prior to 2009. Will home prices be affected when rates increase to more sustainable levels?
This is an important question in the context of whether or not to buy a home in the near-term. In a post last week, I explained that the current environment for home buying is relatively favorable. In particular, I said that as interest rates rise, homes will become less affordable, since mortgage payment size will increase at a given price point. Several readers objected to this line of reasoning, saying that home prices will decline farther as interest rates rise.
What Happens When Mortgage Interest Rates Rise?
Their logic is sensible enough. To understand it, let's imagine a hypothetical universe of perspective home buyers and homes. For simplicity, let's say there are three buyers and four homes for sale. Here's how the market looks (let's also assume no down payments to make things easier):
So at last week's average mortgage interest rate of 4.6%, the first column of mortgage payments applies. In that scenario, Buyer #1 buys Home A, #2 buys B, and #3 buys C. No one buys home D in this example. If interest rates rise by 2%, however, what happens?