How Rising Interest Rates Will Impact U.S. Home Sales

On Dec 14, 2016, the Federal Reserve announced a hike in its benchmark federal funds rate, while indicating three more increases in the coming year. While the increase is certain to lead to pricier loans, it doesn’t necessarily point toward a decline in home buying. To better understand how the rate increase will impact the housing market, consider the following.

What Is the Fed Funds Rate?

To ensure that U.S. banks have a minimum amount of cash to start each business day, the federal government imposes reserve requirements that prevent banks from lending out every single dollar they acquire. To meet these minimum requirements, banks must sometimes borrow reserves from other banks on a short-term basis. The federal funds rate is the interest rate at which these banks borrow reserve funds from one another.

At first glance, these transactions may appear to have little to do with the U.S. housing market. In reality, however, the federal funds rate is highly influential because it indirectly affects interest rates for consumers and businesses throughout the economy. Banks use the fed funds rate to base every other short-term interest rate. This includes interest rates on credit cards, bank loans, deposits and mortgages.

How it Affects Home Sales

Once devastated by the real estate crash, the housing sector has made incredible strides, thanks in part to 30-year fixed mortgage rates that remain below 4 percent. At the same time, the modern housing market is supported by much more than affordable mortgage rates. Steady gains in employment and overall economic growth have also played key roles in boosting home prices and home sales.

While an increase in the Fed fund rate appears to point toward rising consumer mortgage rates, it isn’t necessarily that simple. Long-term mortgage rates vary as a result of several factors, including the budget deficit, inflation rate, household savings rates, the erosion of purchasing power of money, and the federal funds rate. Therefore, any increase in the federal funds rate will have only a limited impact on the overall housing market.

2017 Outlook for Homebuyers

The federal fund rate increase means homebuyers will almost certainly have to pay more for their mortgages. While the Fed doesn’t directly interfere with consumer interest rates, the quarter-point fed fund hike will drive mortgage rates higher, especially when combined with the directional tone of progressive gradual increases.

That said, while 30-year mortgage rates will drift upward slightly, this increase is unlikely to deter most buyers, as long as job growth and aggregate U.S. incomes increase proportionally. At the same time, the 2017 market is expected to be more favorable to home sellers, who are likely to see increased prices. That could prompt more homeowners to become sellers in what has become an increasingly undersupplied market.

In spite of recent rate increases, most experts predict home sales to equal what we saw in 2016. While the federal fund rate increase will undeniably cost prospective homebuyers more when they seek a mortgage, the market is still favorable to homebuyers, thanks to steady job growth, rising household incomes and overall economic expansion.