In real estate, it is generally known that when the interest rate rises, the house prices go down and thereby creating a buyer’s market. Vice versa, when the interest rate falls, the house prices will go up and thereby creating a seller’s market.
What is the relationship between interest rates and house prices?
When the interest rates are high, for example 6.5%, taking out a 30 year home loan on a 400k property will result in a monthly repayment of roughly $2500. If you were to take out the home loan when the interest rate is 4.5%, it will result in a monthly repayment of roughly $2000. This clearly shows that when the interest rates are high, it is not attractive nor cost effective for the potential property buyers to get into mortgage (a.k.a. Death Contract), whether it is for investment or living.
Reluctance showed by the potential property buyers, reduces the demand on the properties. In our example, due to 6.5% interest rate, the 400k houses are now only affordable by a smaller pool of buyers. Lower demand on properties is not an ideal market/situation for property owners to be in when they have to sell their house as soon as possible. Why would someone want sell their house in such situation? For their own financial reasons, it’s not our business.
To achieve their goal of selling their properties as soon as possible, the owners have to increase the demand on their properties which means attract more buyers. The only way to attract buyers in such market is by reducing the price of the properties. In our example, the 400k property could now be going for 350k, making it a bit more attractive and affordable for the potential buyers whom were initially reluctant to even consider the property.
This means high interest, has caused property owners to reduce their property price thereby creating a buyer’s market. The monthly repayment for a 350k property would be roughly $2200 which is certainly better than a $2500 monthly repayment.
When the interest rates are low, the monthly repayments are low as well. This makes buying an investment property or a house to live in suddenly looks more attractive and also affordable. In our example, 4.5% low interest rate for a 400k property results in a $2000 monthly repayment. As people are looking to buy houses, the property owners want to cash in on that. High demand on their property means their properties are now worth more than before.
A 400k house that only attracted a small pool of buyers, will now attract a lot more potential buyers, allowing the owner to increase the price. From our example, from 400k to 450k. With 4.5% interest rate, the monthly repayment for a 450k property would be roughly $2300. As they property has a lot of demand, the potential buyers tend buy the property for an increased amount before they loose the opportunity, may be the best win. If the property is being sold in a area that does not have many properties for sale, the house owner can decide to put their property up for auction. When the bidding wars start, it could end up selling a 400k house for 600k or even more. This is how lower interest rates creates the seller’s market.
Now that we know how the interest rates affects housing market, the next question is what affects the interest rates?