With Mortgage Rates in a Holding Pattern, What Will Housing Prices Do?

After rising by more than a full percentage point from early May till the end of June, 30-year mortgage rates have more or less leveled off since then. However, the impact of higher mortgage rates on the housing market is still unknown.

On July 30, the latest figures for the S&P/Case-Shiller Home Price Indices showed that the housing recovery continued in May, and that their 10-city and 20-city composites posted their strongest year-over-year increases since early 2006. However, since those indices represent three-month averages ending in May, the latest figures just barely overlap the rise in mortgage rates. Thus, it is too early to tell what impact higher interest rates will have on home prices.

Mortgage calculators and other inputs

In part, the relationship between mortgage rates and home prices can be represented on a mortgage calculator. For any given level of monthly payment on a loan calculator, if you increase the mortgage rate the total size of the loan will shrink. That smaller loan size indicates that the lower price point that consumers can afford at that level of payment.

However, there have been several instances historically when home prices have gone up despite rising mortgage rates. Clearly, there must be a factor at work here beyond what you can see on a loan calculator, and that X factor is consumer wealth. If economic growth is improving, then consumers should be getting wealthier and can afford higher mortgage payments. If you increase the amount of the payment you target on a loan calculator, it can offset the impact of rising mortgage rates.

Because of the lag in home-price data, it will only be in the months to come that the impact of higher mortgage rates on the housing market will become apparent. Whether the housing rally can shake off the effects of higher rates depends a great deal on whether the economy starts to pick up any momentum.

The bottom line is that if higher mortgage rates are accompanied by stronger economic growth, the resulting demand can support housing prices even though loans are more expensive. However, if mortgage rates rise for a reason other than improving growth -- such as due to inflation -- then the rally in home prices may not be able to withstand the higher cost of mortgages.