Rising Interest Rates Doesn’t Mean Falling Home Prices

Anyone scanning the internet will see many claims that home prices fall when interest rates rise. This is sometimes stated as an obvious fact, but actually it is simply an urban myth. Just because many people believe it, does not make it true.

Similarly, most people believe:

  • Napoleon was short (he was 5′ 7″ which was quite tall for the period in which he lived)
  • Vikings wore horns on their helmets (no horned Viking helmet has ever been found by archaeologist) – this myth started in the 1800s
  • People only use 10% of their brain (nope, apart from those who think home prices fall when interest rates rise – just kidding)

In the last 50 years there have been dozens of occasions when interest rates have risen. In NO case have home prices fallen as a result – they continued to rise, sometimes gradually or, more often, rapidly.

There have been only two periods when home prices have fallen by any significant amount across the nation in the last 50 years. They both happened during a period when interest rates were in a strong downward trend. Texas suffered a significant fall in housing prices during the 1980s. This was triggered by a surplus of oil causing major disruption to industry and employment in the area. Interest rates were not part of the problem.

The truth is that home prices only fall when there is a large excess of supply compared with demand. Interest rates have a small negative effect on demand, but no effect on supply. Loan approval rates have a more significant effect on demand and these are low and expected to rise at some point, which increases demand. Sales volumes sometimes drop when interest rates rise. This is not the same as prices falling.

The low end of the market is the most susceptible to interest rate changes affecting demand. However, in this segment there is a chronic shortage of supply that has no short term solution. The idea that median prices are therefore going to fall as a result of interest rate rises is extremely far-fetched.

It is possible that prices could fall at the highest end of the market, because supply is already much higher there and demand can be fickle. This would not be a direct result of interest rates, but it could be brought about by major economic problems such as a serious period of deflation or a sustained recession. Rising interest rates usually occur when the Federal Reserve is trying to apply the brakes, almost never during a recession when they usually cause interest rates to fall.

Article courtesy of the Cromford Report