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Question:  

Will higher interest rates slow down the housing market and the economy?

Answer:

The housing market is a key component of the US economy with potential spillover impact to other economic sectors. Interest rates are up in efforts to slow the economy after record breaking monetary expansion during the pandemic. While it’s a priority for the Fed to bring down inflation by raising rates, it is imperative to consider that the repercussions of a declining housing market extend well beyond home prices. 

Mortgage rates have more than doubled from approximately 3% to over 7% today. Existing home prices are up 8.4% year-over-year and the same mortgage costs roughly $1,000 more per month than it did one year ago. The combination between higher mortgage rates and higher home prices has slowed the housing market. The slowdown is good news for the Fed as this is a sign that its strategy of targeting long-term interest rates (mortgage rates) to slow the overall economy is working. 

Home prices do not enter the Consumer Price Index (CPI) calculation, but the services provided by housing do, either in terms of rent or carrying costs, and account for almost one-third of the inflation indicator. As rates go up, home prices tend to go down, putting pressure on rental rates to go lower too. This process historically takes six to twelve months to take place and materialize in changes to monetary policy. Once prices start to decline, the shelter component of CPI should show some relief, ultimately contributing to lower headline inflation reports. 

From an economic perspective, the National Association of Home Builders shows that construction, remodeling, and broker’s fees historically made up 3-5% of Gross Domestic Production (GDP). The largest impact on GDP comes from consumption spending on housing services which averages 12-13% of GDP. These items include rents, owner’s carrying costs, and utilities. The direct and indirect effects of housing for the US economy represent about 15-18% of GDP. The decline we’re starting to see in the housing market will likely have a large impact on the overall economy. 

There are many additional costs associated with buying a home, such as closing fees, appraisals, and inspection costs. Once the home is purchased there are ongoing expenses in addition to a mortgage that include insurance, taxes, maintenance, and more personalized costs for decorating and furnishings which ultimately impacts other businesses.

Data Source: FactSet, as of 11/09/2022