Finance Chair: Interest Rate Raised to Combat Inflation Could Eventually Lower Housing Prices

While increased interest rates have placed home ownership even further out of reach for many Americans, those steadily rising costs might eventually help would-be buyers, said the chair of Cal Poly’s Finance Department.

“House prices are more likely to come down in the longer run as the Fed holds its course of fighting high prices with restrictive monetary policy,” said Professor Ziemowit Bednarek. “In that sense there is definitely hope for prospective buyers.”

Hope is not something non-wealthy, would-be home buyers have experienced much of in recent years.

The median existing home price in the United States reached an all-time high of $407,600, according to Reuters. That’s 14 percent higher than last year.

Finance Professor Ziemowit Bednarek

The situation in California is even worse. According to one expert quoted on KSBY-TV, only 20 percent of Golden State households can afford a median-priced home – a significant drop from 33 percent just two years ago.

While a near record-low 3-percent mortgage rate was attractive to buyers during the pandemic, lack of available housing led to a seller’s market that drove prices upward.

But now that interest rates have increased, so too have mortgage rates, meaning already expensive homes will be even more costly.

“In times of the restrictive, or high, interest rate policy, loans are more expensive for both businesses and individuals,” Bednarek said.

Hoping to prevent a recession, the Federal Reserve has recently increased the interest rate three times since March in an effort to offset the inflation that has impacted the price of goods. That rising interest rate, in turn, results in a higher mortgage rate, which doubled from around three percent to six.

The impact would be obvious to the consumer: The monthly mortgage for a $250,000 home would cost $356 more a month while the mortgage for a $750,000 home would be $1,067 more monthly, the Washington Post recently reported.

A 6-percent mortgage rate might not seem much to those who paid nearly 17 percent in 1981, but today less than 46 percent of homes are affordable on a monthly $2,500 monthly budget, according to Redfin.

A large home under construction in Pismo Beach, CA. As the mortgage rates increase, home sales are likely to decrease, which could slow the pace of construction, according to Ziemowit Bednarek, Cal Poly Finance chair.

Yet, again – there’s a little hope. Because eventually people are likely to just stop buying homes.

“Expensive loans will dampen the consumer demand and, at least in theory, lead to the lower demand in the housing market — and therefore lower prices,” Bednarek said.

But there is a caveat: “Since the Covid 2019 pandemic started in March of 2020, the economy has been undergoing a number of structural shifts,” Bednarek said. “One of those being working from home. People realized that they can move to a cheaper location and keep their job by working online. Of course, this caused the prices in those originally cheap markets to skyrocket.”

Also, higher interest rates could impact the construction of new homes, which already stalled during the pandemic, contributing to higher prices.

“Companies will be less likely to expand and hire, which will only deepen the shortage of new homes,” he said. “This part may, in fact, counteract the effect of expensive credit on the housing market itself, and keep existing home prices up.”

The recent developments prompt mortgage rate strategies. Buyers who lock into a 15- or 30-year fixed rate mortgage would be protected from future interest rate increases. However, there are occasions where a more unpredictable adjustable rate mortgage might make sense.

“If you do not plan to hold on to the house for too long, or if interest rate increases are not expected to last, it may make more sense to go with an ARM,” Bednarek said. “In our current market situation though, it looks as the Fed is poised to keep hiking interest rates in the foreseeable future.”