How Do Lower Interest Rates Affect Real Estate Prices?

In March 2022, the annual inflation rate in the U.S. stood at 8.5%, the highest since the early 1980s. One way the Federal Reserve (Fed) combats high inflation is by raising interest rates.

The central bank raised rates a quarter of a percentage point. But they say there could be up to six more potential increases this year.

Whether interest rates are high or low, they affect real estate prices. So let’s discuss how lower interest rates affect estimated home values and mortgages.

Supply and Demand in Real Estate

Of course, supply and demand for real estate and replacement costs of developing new properties affect real estate costs.

Right now, the market is a “seller’s market” because there is more demand than supply. As a result, inventory is short, so prices go up. Buyers also often need to provide better offers to secure a property.

This could be making an above-ask offer, paying all cash, or getting rid of contingencies.

But the market is more complex than that.

Interest Rates

Interest rates, capital flows, and financing rates also affect median home prices. Investors use the income approach to determine home value. This approach takes net cash flow (NCF) into account.

The central bank sets the interest rate, which banks use to determine the range of annual percentage rates (APRs) they offer customers. A lower interest rate set by the central bank means a lower APR on your mortgage.

Thus, you can take out a mortgage to finance a property and pay less in interest over the loan’s lifetime, saving you money.

But, the Fed raises short-term interest rates to control inflation, which affects long-term rates. One example is the yield on the U.S. Treasury 10-year bond.

30-year mortgage interest rates correspond directly with the U.S. Treasury 10-year bond, further showing the link between interest rates and housing costs.

Higher interest rates increase the cost of debt, which discourages spending and slows down demand. Hence why the Fed recently raised rates and says more hikes are coming.

Slowing down demand will help lower housing costs, which increased nearly 20% last year.

Capital Flows

Because interest rates affect the cost of financing and mortgage rates, they also affect property-level costs and home values.

When interest rates are low, the cost of funds is reduced, and money flows into the system. But, when rates are high, the availability of funds decreases.

Changes in capital flow impact supply and demand in the real estate market. For example, a lower interest rate provides more funds and, therefore, more property buyers. Over time, the market gets more competitive and expensive, so the Fed has to step in to raise rates.

Although the Fed will raise rates steadily this year, interest rates are still low compared to other times in U.S. history.

How Lower Interest Rates Affect Real Estate

With a better understanding of how lower interest rates affect median home prices and mortgage rates, you can determine whether now is the right time for you to move or not. Speaking with a financial advisor can also help you make this decision.

If you gained valuable insights into the real estate market with this article, don’t miss other great content on our blog.

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