Silver Linings Playbook: Why Higher Rates Are Actually Good for Homebuyers

Let’s face it: We’ve been living in a bubble. Mortgage rates under two percent? If you’d have said that sentence to someone ten years ago they’d laugh you out of the room. Well, turns out there’s a reason for that, and that reason is smacking us all in the face like we’re a certain unlucky Oscar host right now.

As it turns out, historically low rates are like everything else: a good thing that eventually comes to an end. And like all good things, that end came a bit out of the blue. Homebuyers and refinancers are suddenly looking at rates over 4% for the first time in several years.

But while those pandemic-era rates of 2-3% were like finding a pot of gold for homebuyers and refinancing homeowners alike, these new, higher rates carry with them an extremely sweet silver lining no one seems to be talking about in this ultra-hot housing market: lower home prices.

Freddie Mac Spikes Over 1%

Money’s latest report is a tough pill to swallow: the current average mortgage rate of 4.16% is the highest mark we’ve seen since the spring of 2019. Worse yet, most market experts anticipate rates climbing even higher.

Fannie Mae’s Home Purchase Sentiment Index saw nearly two-thirds of respondents saying they expect rates to continue spiking through the year. But here’s the catch: higher rates aren’t necessarily a bad thing for buyers.

The market has been hot. Almost too hot if you ask many potential buyers, who’ve been subjected to vicious bidding wars where they’ve been forced to compete with dozens of other buyers for the same property, driving prices sky high.

Combine that with low inventory and you have a recipe which many sellers are calling the perfect storm. As Ralph McLaughlin, chief economist at Kukun recently put it: “Rising rates may help tamper down demand somewhat to the point that it would help the housing market look more normal. Because we are certainly in an extremely abnormal market.”

Tempering Home Prices

The past twelve months saw home values jump by almost 20%. Again, we’ve been caught in the perfect storm of high demand and low supply. But as rising rates threaten the affordability of mortgage payments, most market experts predict a considerable drop in home prices.

The result: less competition. Less bidding wars. Cheaper houses. When asked about cooling home prices, Redfin’s deputy chief economist, Taylor Marr, noted the long standing history of rising rates dropping home prices to an absolute minimum.

When looking at the data, we see that an average mortgage rate increase of 1% drops home prices by 5% or more. The housing market is poised for such a drop as we speak. What we’re seeing now is likely the dying breaths of a hot market, as the last of the bidding war crowd rushes in to try to snatch up real estate before rates climb higher.

Marr: Higher Rates Balance Price Growth

It’s simple cause and effect: higher rates equals less competition. Many homebuyers are simply priced out of the market, meaning sellers will have no choice but to lower their asking price. As Marr put it, when you look at the year over year analysis, mortgage payments are up 25% from March 2021.

The average mortgage payment sits at a record high of $2,123. The only place that number has to go from here is down. We are poised for a significant pricing drop, meaning lower payments, less interest, and more home equity than ever before.

Many buyers are simply taking a step back, and this may be the end of the bidding wars as we’ve known them. That also spells more inventory as demand slows. Homes will sit on the market longer, supply will build, and buyers will have more choices and leverage.

More Listings Equals More Leverage for Buyers

All signs are now pointing to less leverage for sellers. The power shift is happening right before our eyes, with buyers suddenly finding all the leverage falling right into their laps. According to Marr, “All we really need is listings to be on par with demand and then the market to slow a little bit to get that inventory build-up that would be a more balanced and healthy market.”

As inflation continues its hold around the country (and the world), combining with the Ukraine conflict, the sanctions against Russia, compromised oil supply chains leading to increased gas prices, and growing instability across the global economy, a course correction is the only outcome that makes sense.

The Federal Reserve sees things this same way. This spring’s Federal Open Market Committee meeting saw the Fed announce a 0.25% rate increase. Additionally, the Fed’s higher ups hinted at multiple increases throughout the calendar year. But this isn't necessarily a bad thing, as we've discussed in great detail here today.

What This Means for Borrowing Money

Rising Fed rates typically slow the economy as both individuals and businesses have a higher bar to leap over in order to receive monies. But it’s all about the silver lining here: lower demand ultimately drops costs, including housing costs.

Additionally, banks themselves will be paying more interest on products, which in turn encourages individuals to save funds and build wealth. In other words, higher mortgage rates ultimately drop the costs of everything else (especially home prices themselves), meaning more savings than ever for home buyers.

This is why increased rates are really nothing to worry about in the short and long term. If you’re facing affordability obstacles due to rates climbing over 4%, remember that home prices are likely to drop significantly in the coming weeks.

Act Now Before Rates Hit 5%

This is really the key number, or benchmark, we need to be looking at. Right now, rates at or even below 4% are still available to refinancing homeowners and potential home buyers alike. Market experts agree: don’t wait for them to climb above 5%. If you’re thinking or buying a new home, or refinancing your current one, now is the time to strike.

It’s been over a decade since we’ve seen the average mortgage rate spike above 5%. If they jump even higher, up to 7-8%, like they were after the Great Recession of 2008, we could see home prices drop dramatically.

Right now, when you look at the greater historical context, rates are still extremely low. The fact that you can still lock in a rate under 4% is all you really need to know. Just make sure you take action before a potential major spike that may be imminent by the end of this year.