The Impact of Higher Interest Rates on the Housing Market | U.S. Bank (2024)

The U.S. housing market continues to bear the brunt of today’s elevated interest rate environment. As the Federal Reserve (Fed) holds firm to its strategy of maintaining the federal funds target rate it controls at its highest levels since 2007, average 30-year mortgage rates nationwide have risen above 7% for the first time since late 2023.¹ Higher rates, combined with rising home values, means housing is now a much costlier expense for potential buyers than was the case only a few years ago.

The housing market represents a segment of the economy directly impacted by rising interest rates. Since 2022, the Fed raised rates more than 5% to stem the tide of surging inflation. Interest rates for all types of borrowing including home mortgages rose in conjunction with Fed rate hikes. A positive sign is that the Fed stopped raising rates by mid-2023. However, despite speculation about possible cuts this year, there is no clear timeline for when the Fed might begin cutting interest rates. The market headwinds resulting from higher interest rates are evident in existing home sales data. March 2024 existing home sales fell 4.3% compared to February’s sales and are down 3.7% compared to a year earlier.² The decline occurred despite what appears to be solid housing demand.

An altered landscape forces homebuyer adjustments

“The biggest changes to the housing market landscape have already happened,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “With the Fed apparently done raising rates for now, a degree of uncertainty is removed from the market.” Haworth notes that even if rates don’t trend lower anytime soon, those in the home-buying market won’t likely see another spike in mortgage rates. “That allows people to better plan as they determine what they need to budget for housing costs.”

Home prices recover

Home prices, like those for any product or service, are driven in large part by supply and demand. After Fed rate hikes began, housing demand dipped and prices followed suit, falling between July 2022 and January 2023. Prices recovered modestly from February through October 2023, when prices in the S&P CoreLogic Case-Shiller reached new, all-time highs. Home prices as measured by the index then slipped in three consecutive months before recovering again in February 2024. But according to the S&P CoreLogic Case-Shiller 20-City Composite Home Price Index, home values fully recovered from that seven-month decline. By October 2023, average home prices nationwide reached new, all-time highs, but values slipped modestly since then. Home prices, based on this national average, are up 7.3% from a year earlier.³

The combination of higher prices and stubbornly high mortgage rates has dampened housing market activity. For all of 2023, mortgage applications for home purchases fell to their lowest levels since 1995. In late April 2024, the unadjusted Purchase Index for mortgage applications was 15% lower than the same week a year earlier.⁴

Homebuyers are increasingly turning to the new home construction market. New-home sales continue to strengthen, up an impressive 8.3% in March 2024 compared to a year ago. New home sales stood at a seasonally adjusted annual rate of 693,000.⁵ Haworth says new home sales help meet demand, but only partially. “With new home sales approaching 700,000 per year, that does not fully make up for the shortfall in existing home inventory,” says Haworth.

The average 30-year mortgage rate in the U.S., which was below 3% until late 2021, peaked at 7.79% in late October 2023.⁶ That represented the highest mortgage rate since November 2000. The result is more costly borrowing, which can dampen housing market activity. Rates declined from October’s peaks, down to 6.60% in February, but are now back above 7%.⁶ The upturn in mortgage rates may reflect expectations that the environment will not accommodate meaningful Fed interest rate cuts anytime soon.

The current environment leads to what may be the highest housing costs of all time. According to the residential real estate brokerage firm Redfin, the median monthly mortgage payment in April 2024 (based on average 30-year mortgage rates and home prices) was $2,843, 13% higher than the median mortgage payment one year prior.⁷ “The combination of higher home prices and elevated mortgage rates creates a meaningful headwind for new homebuyers,” says Haworth. “They either need to be able to make a bigger down payment or they must earmark more of their monthly budget for housing costs.”

Impact on real estate investing

For those looking for portfolio diversification by including real estate in their asset mix, a commonly used vehicle is a real estate investment trust (REIT). However, higher interest rates create headwinds for REITs.

“Although REITs are often considered a way to hedge the risk of higher inflation, the unfavorable interest rate environment has resulted in REITs underperforming other parts of the equity market,” says Tom Hainlin, national investment strategist at U.S. Bank Wealth Management. “Improved yields on U.S. Treasury securities create cash flows that look much more attractive in today’s market when compared to REITs.” As a result, demand for REITs has fallen. Year-to-date through April 30, 2024, REITs are again in negative territory, with the Developed REIT index returning -7.2%, compared to a year-to-date total return of 6.0% for the broader S&P 500. Over the 12-months ending April 30, 2024, the S&P 500 gained 22.7% while the Developed REIT index was essentially flat.⁸

Housing’s economic influence

Fed policy has clearly placed housing and other real estate markets on the front lines of efforts to slow the economy's pace and lower inflation. Thus, regardless of the extent of your real estate holdings, it’s important to keep in mind that the housing market can have a significant impact on the broader economy and capital markets generally. “The formation of households is one of the main drivers of economic growth in the U.S.,” says Hainlin. “It has a large spillover effect on the economy, including materials that go into building or remodeling, and furnishings for homes.”

Be sure to consult with your wealth management professional to determine when and how real estate investments might be a good fit for you.

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