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Inflation and housing interest rates are closely linked, as changes in inflation can directly impact the interest rates that lenders charge for mortgages. In general, when inflation is high, interest rates tend to rise, making it more expensive for borrowers to take out a mortgage.
But why? Why is the relationship so complex in the housing market?
First, let’s get on the same page about simple supply and demand. Then we’ll layer in the complexity of the housing market, which is not so simple. We’ll use the classic example of the lemonade stand.
Think about a kid’s classic lemonade stand. Maybe you had one of your own! Your parents helped you get set up and you sold lemonade for $1 per cup–a fair price considering the cost of your supplies and labor. Once it ran out for the day, you found more supplies in your kitchen, and restocked so that you could stay in business at the same prices. Even if all of your supporting neighbors lined around the block, your pricing could remain stable as your suppliers (mom and dad) kept you stocked up with sugar and lemons and water from the tap. If you were business savvy as a child, you may have charged an extra quarter to slow demand while you managed supply. The lemonade stand is a simple business, so it’s fairly straightforward. The housing market? It’s different.
What happens when there’s a high buying demand in the housing market?
When there is high buying demand in the housing market, home prices go up just like they did with the popular lemonade stand. But unlike stirring up a cup of lemonade to meet demand, in contrast, the housing supply will remain limited. That’s because it’s much more difficult to quickly increase the supply of homes. It takes much more capital and much more time to build homes. So when supply is stagnant and demand is increasing steadily, home prices will increase. And since we can’t slow demand or increase supply, home prices are at risk of skyrocketing. Therefore, the federal government steps in to slow the home price increase with interest rates.
What do interest rates have to do with housing supply and demand?
The US Federal Reserve attempts to slow the demand for housing by raising interest rates on mortgages. Raising interest rates means that it will be more expensive for home buyers to borrow money. On top of the home prices increasing, buyers must also consider the increased cost of borrowing the money to buy the home. This is similar to how you charged an extra quarter to slow down his lemonade sales to keep your supply in check. Home buyers may have to adjust their home buying budgets to accommodate the increased cost of borrowing money on top of the cost of their dream home. By increasing interest rates, the Feds are attempting to control and slow the increase in the cost of a home. It’s a way to slow things down until supply goes up or until demand goes down.
How Should a Home Buyer Prepare for Changes in Interest Rates?
With interest rates increasing, buyers may have to rebudget or reconsider what they’re looking for in a home. The amount of money you have doesn’t change, but now you have to consider setting more aside for the cost of the mortgage, rather than the cost of the house itself. I can help you determine the best way to make adjustments as you’re looking for your dream home in Rochester. For example, maybe you wanted to stay in the Pittsford School District. Great! This might mean we find you a house with less square footage than you were originally looking for, or maybe skipping the brand new flooring for now. Your budget has been reallocated slightly from principal to interest.
What about when interest rates go down?
That’s typically a good thing for home buyers! You’ll be able to reallocate that percentage back toward your principal budget. The lower the rate, the more money you can put toward your dream home.
We can talk about the details when you reach out. My goal is to help you find your dream home and get the best value for your budget. I’ll gladly guide you through different ways you can approach home buying when we start working together. As always, your realtor is here to support you. Team Austin is ready to help you on the journey to your dream home.
