Why Higher Mortgage Rates Are Actually Beneficial to Homebuyers?

For the first time since the pandemic, homebuyers are facing mortgage rates exceeding 4% for the first time. While low rates helped homebuyers and refinancers at first, increased rates may be a godsend for an overheated housing market.

Freddie Mac's benchmark rate has increased by more than 1% since the beginning of the year. The current 30-year average mortgage rate of 4.16 percent is the highest since May 2019.

Most homebuyers believe rates will continue to rise. In Fannie Mae's recent Home Purchase Sentiment Index, 67% of respondents stated they expect mortgage rates to continue to rise throughout the year.

Higher rates will undoubtedly put a strain on housing affordability, but they may also offer a ray of hope for the housing market as a whole. That's because the rate hike comes in the midst of a fiercely competitive market with minimal inventory and sky-high housing prices.

Slower rise in housing prices 

Due to a lack of supply and great demand, housing prices soared by about 20% last year. As interest rates rise, monthly mortgage payments become less affordable, home price increases may slow.

There is a historical association between rising interest rates and lower home price increases, according to Taylor Marr, deputy chief economist for brokerage Redfin. In a typical year, a rise in mortgage rates of 1% results in a 5% decrease in price growth. (Note that this is a decrease in the rate at which sales prices rise, not in the actual price.)

This time, the market has yet to experience that influence. In fact, the sudden increase in interest rates has resulted in a surge in demand as homebuyers rush to lock in rates before they rise further.

However, when interest rates rise at a more gradual pace, as most market observers believe, price inflation should begin to decelerate. 

Fewer competitors

Some potential homebuyers will be priced out of the market as interest rates rise. This is bad news for them, but wonderful news for the remaining buyers.

According to Marr, the average mortgage payment for a newly listed home has increased by 25% since mid-May last year. The monthly mortgage payment on a typical home has reached an all-time high of $2,123 at this time.

She predicts that once interest rates begin to rise more slowly and steadily later this year, some buyers may need to wait.

Increased housing supply

Homes should stay on the market a little longer as demand slows, allowing inventory to increase and relieving the supply bottleneck.

There were already hints of a little recovery in home supply in May, as demonstrated by a smaller drop in active listings compared to the previous year. While no one expects a flood of new homes to arise overnight and eliminate the housing need, the indicators are promising.

Higher savings rates

The rise in home prices isn't the sole economic signal. In May, consumer price inflation hit 7.9%, the highest level in 40 years. The war in Ukraine and the sanctions imposed on Russia as a result of it threaten to drive up inflation much more, particularly the prohibition on oil imports, which is already driving up gas costs.

At its May meeting, the Federal Reserve raised the federal funds rate by 0.25 percentage point, thus raising the rate at which banks lend each other money on a short-term basis. Another six rate hikes are expected this year, according to the central bank.

Raising the federal funds rate, in effect, will slow the economy by making it more difficult for individuals and businesses to borrow money — including for homes — reducing demand and, as a result, lowering prices on a variety of services and goods. 

As interest rates climb, banks should provide more interest on savings products, urging clients to save and build wealth. For homebuyers, there is a middle ground. Although mortgage payments may rise, other costs should fall and the savings rate should climb.

How high must rates rise before they become an issue?

Some borrowers are already suffering affordability problems as mortgage rates are near 4%, but experts we spoke with believe rates can still rise before affecting the larger market. However, at around 5%, some analysts predict rates will start to have a bigger impact.

Mortgage rates would have to rise to as high as 7% to 8% for an extended period of time before property prices began to decrease. Keep in mind that interest rates are not as low as they were a year ago.