What the Fed’s December rate hike means for home buyers and sellers

The Federal Reserve has hiked interest rates for the seventh straight year this year. This time, however, the hike is smaller: Fed Chair Jerome Powell announced a half-point hike in interest rates on Dec. 14, down from three-quarter-point hikes at recent meetings. The last time it hiked rates that much in a single year was in the 1980s.

To curb raging inflation, the Fed hiked rates by a quarter point in March 2022 and by half a point in May. It hiked it even further by three-quarters of a percentage point in June — what was then the largest Fed rate hike since 1994 — and did the same in July, September and November.

The increases are intended to cool an economy that was on fire after recovering from the 2020 coronavirus recession. Included with this dramatic recovery was a red-hot housing market marked by record-high house prices and microscopic inventories.

However, since late summer the housing market has shown signs of cooling, with appreciation slowing across the country and prices even falling in many markets. And home prices are driven not just by interest rates but by a complicated mix of factors — making it difficult to predict exactly how the Fed’s efforts will affect the housing market.

“The housing recession is here,” says Marty Green, director of mortgage firm Polunsky Beitel Green. “The big question now is how quickly it spreads to the rest of the economy.”

Higher rates are challenging for both homebuyers who are dealing with higher monthly payments and sellers who are experiencing lower demand and/or lower listings for their homes.

“The cumulative effect of this sharp rise in interest rates has cooled the housing market and caused the economy to begin to slow, but hasn’t done much to lower inflation,” said Greg McBride, CFA, Bankrate’s chief financial analyst.

How the Fed affects mortgage rates

The Federal Reserve doesn’t set mortgage rates, and central bank decisions don’t move mortgages as directly as other products like savings accounts and CD rates. Instead, mortgage rates tend to move in step with 10-year Treasury yields.

Still, the Fed’s behavior sets the overall tone for mortgage rates. Mortgage lenders and investors are watching the central bank closely, and the mortgage market’s attempts to interpret the Fed’s actions affect how much you pay on your home loan.

December’s rate hike was the seventh hike in 2022, a year in which mortgage rates fluctuated wildly, from 3.4 percent in January to 7.12 percent in October before slowly easing back. “Such increases reduce the affordability of the purchase and make it even more difficult for low-income earners and first-time buyers to buy a home,” said Clare Losey, academic economist at Texas A&M University’s Texas Real Estate Research Center.

To what extent do mortgage interest rates affect housing demand?

There’s no doubt that record-low mortgage rates helped fuel the housing boom of 2020 and 2021. Some believe this was the single most important factor that kickstarted the housing market.

Now that interest rates have risen by the highest rate in two decades, how will that affect home sales and prices? “Mortgage Interest [have] effectively halted refinancing activity and significantly reduced home buying activity,” said Mike Fratantoni, chief economist for the Mortgage Bankers Association. Not only have sales slowed, but economists are expecting price declines of a few percentage points to more than 20 percent.

Over the long term, however, home prices and home sales tend to be resilient to rising mortgage rates, real estate economists say. That’s because the individual life events that trigger a home purchase — having a child, getting married, changing jobs — don’t always align well with mortgage interest rate cycles.

History confirms this. Mortgage rates rose as high as 18 percent in the 1980s, but Americans still bought houses. Rates of 8 to 9 percent were common in the 1990s, and Americans continued to snap up houses. During the housing bubble of 2004-2007, mortgage rates were higher than they are today – and prices rose.

So the current slowdown could be the return to normal of an overheated market rather than the signal of an incipient crash. “The combination of increased mortgage rates and a sharp rise in home prices in recent years has severely reduced affordability,” says Fratantoni. “The volatility seen in mortgage rates should ease once inflation slows and the peak interest rate for this hiking cycle comes into view.”

For the time being, however, the housing market remains difficult for buyers. “The housing sector is the most sensitive to changes in Federal Reserve interest rate policy and experiences the most immediate impact,” said NAR Chief Economist Lawrence Yun. “Weakness in home sales reflects this year’s escalating mortgage rates.”

Yun says the average monthly mortgage payment rose 28 percent over the past year, a minor sticker shock that’s bound to reverberate through the housing industry. “My expectation is that the pace of price increases will slow down as demand cools and supply improves a bit due to increased housing construction,” he says.

In fact, the National Association of Realtors (NAR) says the housing shortage is already easing as demand falls. The inventory of homes for sale rose to 3.3 months inventory in October, compared to a record low of 1.6 months in January.

Next steps for borrowers

Here are some tips for dealing with the climate of rising interest rates:

Look for a mortgage. Smart shopping can help you find a better than average price. As the refinancing boom slows, lenders are eager for your business. “Searching online can save thousands of dollars by finding lenders that offer a lower interest rate and more competitive fees,” says McBride.

Be careful with ARMs. Adjustable-rate mortgages are becoming more enticing, but McBride says borrowers should stay away. “Don’t fall into the trap of using an adjustable rate mortgage as an affordability crutch,” says McBride. “There is little upfront savings, averaging just half a percentage point over the first five years, but the risk of higher interest rates in the coming years is high. New customizable mortgage products are structured to change every six months rather than every 12 months, which was previously the norm.”

Consider a HELOC. While mortgage refinancing is on the decline, many homeowners are turning to home equity lines of credit (HELOCs) to tap into home equity.