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30-year fixed interest rates have hit a historic low today: 3.83%. I happen to live in the second hottest real estate market in the nation and am considering purchasing my first home, which would be my primary residence -- not an investment property. I intend on staying in the home for 7+ years. I am finding desirable properties are under contract within 12 to 48 hours of going on the market. Realtors tell me that there are lots of buyers shopping for homes in my price range. This seems to have increased prices several percent when compared to the 2008-2011 timeframe.

I'm worried that I'll buy today, lose my job in a few years, burn through my 6-month emergency fund and be forced to sell my home. If interest rates increase, I suspect housing prices will decrease, putting me under water. How do interest rates affect real estate prices?

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    "Realtors tell me that there are lots of buyers shopping for homes in my price range." IMO, never listen to what realtors tell you about what's moving. They always say that it's a "great time to buy" or you should act fast--they're salespeople, what else would they tell you?
    – Chelonian
    May 10, 2012 at 18:04
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    I'd also try to calculate the risk you describe as best you can. If your career is really lacking in robustness to that degree, and your mortgage burden will be that severe, maybe you shouldn't be considering buying a home?
    – Chelonian
    May 10, 2012 at 18:06
  • Here is an article on that very topic: businessweek.com/lifestyle/content/dec2009/…
    – JohnFx ♦
    May 10, 2012 at 18:42
  • Here is another article that posits that there is no significant correlation (math included!): seekingalpha.com/article/…
    – JohnFx ♦
    May 10, 2012 at 18:43
  • Off-topic: Any market where properties are turned around in less than two days is not a market I would have any interest in purchasing in. The ideal purchasing conditions have passed - something a lot of folks fail to see.
    – gef05
    May 10, 2012 at 22:58

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The article John cites says no correlation, but this chart from the article says otherwise;

Housing VS Interest rates

One sees the rate drop from 14% to 4% and housing rise from an index of 50 to near 190. (reaching over to my TI BA-35 calculator) I see that at 14%, $1000/mo will buy $84,400 worth of mortgage, but at 4%, it will buy $209,500. 2-1/2 times the borrowing power for the same payment. But wait, my friends at West Egg tell me that inflation means I can't compare $1000 in 1980 to the same $1000 in 2010. The $1,000 inflates to $2611 (i.e. an income rising only with inflation, no more) and that can fund a mortgage for $546,900. This is 6.5 times the original borrowing power, yet the housing index 'only' rose 3.8X. See that crazy chart? Housing actually got cheaper from 1980 to the peak. Statistics can say whatever you wish. Interest rate change drove all the change in housing prices, but not quite as much as it should have.

To answer your question - I expect that when rates rise (and they will) housing prices will take a hit. In today's dollars, a current $1000 borrows (at 4%) nearly $210K, but at 6%, just $167K. If rates took a jump from these record lows, that's the nature of the risk you'd take.

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  • Some of that chart says otherwise; the rest of it doesn't. From about 1950--1980 there was a steadily rising interest rate...and a steadily rising housing index. Other parts change in other ways (one goes up, the other stays flat). How much of the home price index spike is really due to a long stretch of good economy + mortgage deregulation?
    – Chelonian
    May 11, 2012 at 0:43
  • Understood. And I agree. As I tried to show, inflation isn't taken into account at all. If one were to create a third line, the mortgage that one could afford at the prevailing rate using 25% of median monthly income, it would correlate far better to the housing index, and you'd see that housing at the '06 peak was cheaper (in person hours) than in 1980. When ever an old person (I am near 50, so now old is like 85) talks about when things wee cheap, I ask, "how many hour's wage did that cost you then?"
    – JTP - Apologise to Monica ♦
    May 11, 2012 at 1:42
  • You applied inflation on the rate, but not the loan. If you say $1000 in 1980 is the same as $2611 in 2010, then $84,400 mortgage also had the same buying power as $220,368 today - so let´s stay with the statement that buying power 2-1/2 timed.
    – Daniel
    Apr 25, 2018 at 12:29
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Interest rates do generally affect house prices but other factors do too, especially the unemployment rate. However, everything else being equal, when interest rates drop, it makes the borrowing of money cheaper so tends to stimulate the economy and the housing market, increasing the demand for houses and generally causes house prices to increase (especially if the supply of new housing doesn't increase with the demand). When interest rates go up the opposite happens. Usually interest rates go down in order to stimulate a slowing economy and interest rates go up to slow down an overheated economy.

Regarding your situation you are able to get a 30 year fixed rate at today’s interest rates (in Australia the longest fixed rate you can get is for 10 years and the rate is usually 1 or 2 percent higher than the standard variable rate. Most people here go for the variable rate or a fixed rate of between 1 to 3 years). This means that even if rates do go up in the future you won't be paying a higher rate, which is a positive for you. You are buying the house to live in so as long as you can keep making the repayments you should not be too worried if the price of the house drops sometime in the future, because if your house has dropped and you want to sell to buy another house to live in, then that house would have also dropped relative to yours (give or take).

So your main worry is that rates will go up causing both house prices to fall and unemployment to rise, and you yourself losing your job and eventually your house. It is a risk, but what you need to consider is if you can manage that risk. Firstly, I believe rates won't be going up in the US for a number of years, and if and when they do start going up they will most probably start going up slowly. So you have some time on your side. Secondly, what can you do between now and when interest rates do start going up in a few years:

  1. Try to put more saving away to increase your safety net from 6 months to 12 months or more, or make extra repayments into your home loan so that you are ahead if things do go wrong.

  2. If you are worried that you could lose your job, what can you do to reduce your chances of losing your job or increasing your chances of getting a new job quickly if you do lose it? Improve your current skills, get new skills, become an invaluable employee, or look at possible opportunities to start your own business.

  3. Do your own research on the types of houses you are looking at buying, the more houses you look at the better prepared you will be when the right house at the right price comes along, and the less chance that you will be rushed into buying what might be an overpriced house.

So to sum it up; do as much research as you can, have an understanding of what your risks are and how you are going to manage those risks.

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  • "... or make extra repayments into your home loan so that you are ahead if things do go wrong." I'm pretty sure that's not the way mortgages work in the U.S.. Consider this silly example: take a 30 year mortgage with 20% down. On the first payment, pre-pay 79% towards principal. You now own 99% of the house. If you miss your second payment (due 1 month later), your house could go into foreclosure.
    – Pete
    May 11, 2012 at 15:21
  • Pete - absolutely right. On standard US mortgages, a payment is due each month. For a time, I had a fixed equity loan, if I made a full extra payment, the due date went out. I got it paid a year ahead at one point. Too bad, the regular fixed dropped my rate just fine, but now payment due every month.
    – JTP - Apologise to Monica ♦
    May 12, 2012 at 0:01
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    @Pete, sure if that's the way mortgages work in the US, but if you have made extra repayments can you then redraw on those extra repayments? Say you are $20K ahead with extra repayments; can you make a redraw of $10K and use that as part of your emergency funds for future monthly payments? In Aust. we are able to make these redraws and we also have offset accounts.
    – Victor
    May 12, 2012 at 1:07
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    An offset account is a savings account which is opened together with the home loan and they are linked to each other. You don't get interest on your savings account but it offsets any interest you have to pay on your home loan. For example, is you have a $100,000 mortgage with a linked 100% offset account with $10,000 in it, you only pay interest on $90,000. The money in the offset account is at call and you can use it whenever you like.
    – Victor
    May 12, 2012 at 1:12

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