As a response to inflation and concerns about the economy overall, the Federal Reserve (aka, the Fed), America's central bank and the autonomous organization responsible for our monetary policy, has committed to increasing interest rates. Already, mortgages and other financial products are showing higher interest rates as a result, creating new economic dynamics that investors and everyday consumers must consider when making major financial decisions.

It appears as though the Fed isn't interested in reversing this decision anytime soon; in fact, there are some indications that further interest rate hikes will await us in the near future.

For some prospective home buyers, this is actually good news. Is it possible that interest rate hikes force housing prices lower? And if so, should you wait for higher interest rates to make a purchase?

Timing the Housing Market: A Word of Caution

First, we need to issue a word of caution about attempting to time the housing market. Obviously, the best real estate investing strategy involves buying low and selling high; in other words, buying real estate when prices have reached a valley and selling real estate when prices reach a peak. If you can take advantage of the natural, and sometimes unnatural fluctuations of the real estate market, you can make a fortune.

Unfortunately, this is an impractical dream for most investors. The real estate market is incredibly tumultuous, and in many ways is unpredictable, because it depends on so many uncontrollable external variables. Working with a property management expert can help you better understand the natural fluctuations of the market and ultimately help you make better real estate investing decisions. But even then, if you're looking for a “perfect” time to buy a piece of real estate, you're probably not going to find one.

Instead, the best approach is to follow a sensible, consistent strategy over the course of years, or even decades. This way, you'll be insulated from market volatility, and you'll be in a much better position to see favorable results.

The Role of Federal Reserve Interest Rates

When we say interest rates, what do we mean?

The Federal Reserve’s target effective federal funds rate dictates interest rates for banks across the board. When banks have access to more favorable interest rates, they give more favorable interest rates to consumers; when they have higher interest rates, they pass higher interest rates to consumers.

The ripple effect goes something like this. When interest rates are low, buyers become incentivized to buy more houses because of favorable debt conditions and lower monthly payments. This sharply drives up demand, pushing housing prices higher. When interest rates are high, we typically expect a reversal of this tendency; buyers are dissuaded from buying houses because of high interest rates and high monthly payments, so prices cool.

However, it's worth noting that there are pros and cons to buying in these different sets of conditions. High interest rates may be associated with lower prices in general, but high interest rates themselves can be harmful to your personal finances.

The Complicating Variables

There are also some complicating variables that prevent us from saying that higher interest rates always or reliably lead to lower prices.

·       Available inventory. We must consider available inventory. Higher interest rates may have the potential to cool off demand, but if supply remains sufficiently tight, it's not going to matter. Millions of people bought homes when interest rates were super low, so they're not interested in selling anytime soon; in addition to stagnating rates of construction and the tendency for older folks to move less often, this has led to restricted inventory and relatively high prices.

·       Investor actions. Investment firms have been aggressively buying up single-family homes and certain other types of real estate for the past few years. This has artificially increased demand, making it more difficult for new buyers to enter the market.

·       The overall economy. Overall economic conditions also affect the housing market. Interest rate increases are designed to keep consumer demand in check, reducing inflation and incidentally curbing economic growth. But if this doesn't rattle consumer optimism or slow down economic growth too much, it may not have the dampening effect on housing prices that it otherwise would.

·       Local dynamics. It's also important to recognize that the real estate market is huge and full of microcosms that deviate from general norms. In other words, just because the overall housing market is acting a certain way doesn't mean you can't find isolated communities where the opposite momentum has manifested. No matter what other conditions are in play, you'll be able to find some cities with very attractive real estate deals and some cities with nothing that isn't ridiculously expensive.

·       The ripple effect of lower housing prices. We should also point out the complex ripple effect of lower housing prices, which can sometimes prevent prices from dropping excessively. If prices drop slightly, and millions of people take it as their moment to buy, it can bring downward price momentum to a total halt – and bring us back to square one.

In summation, logic would suggest that higher interest rates lead to lower housing prices, but this isn't always the case, and it doesn't appear to be the case now or in the immediate future. Before making any real estate decision, it's important to talk to experts who can provide you with perspective and look out for your best interests. Always do your due diligence and trust your real estate agent.