How Interest Rates Influence Real Estate Buying or Selling Decisions?

By Atif Mehar On Sep 20, 2023

Whether you are in the market for a new home or placing your home on the market, there are several personal considerations and macro factors you need to take into account. Macro factors like the current economy, housing market orientation (buyer or seller market), and current inventory (how many houses are on the market) can substantially influence your transactions and, therefore, should be considered before you make one of the most significant financial decisions of your life.

Interest rates are one of the most impactful macro factors you need to consider before you make a real estate decision, no matter which side of the transaction you are on.

For Buyers

For most buyers, the simplest version of interest rates’ influence on their buying decision is:

When interest rates are high, the cost of borrowing goes up significantly, and mortgage becomes expensive. This doesn’t influence cash buyers.
When interest rates are low, mortgages are cheaper. It’s possible to save as much as $165,000 on a 30-year fixed mortgage (for a $500,000 property) if your interest rate is just 2% lower, i.e., 3% instead of 5% (Excluding additional regular expenses like property tax and HOAs/monthly maintenance.)

However, it’s not as simple. Interest rates don’t just influence how much you will pay. They also influence market activity. Historically, low interest rates can stir significant buying activity in any market. Many potential buyers who would have otherwise waited may join the market just to take advantage of low interest rates.

However, the inventory may not expand proportionally. If the number of properties on the market is the same and the number of potential buyers increases rapidly, it may create a seller’s market. The fear of missing out on the right home may encourage the buyers to pay more for the desired property, pushing the prices up.

The actual tipping point differs for each market and multiple factors, but there comes a time when the money a buyer may have saved through the low interest rate mortgage may go towards the price increase.

In contrast, higher interest rates may curb buying activity and cause many potential buyers to wait for better rates to join the market. If the interest rates are high enough to trigger a “buyer’s market” where more homes are available on the market than there are buyers, the prices may fall. The impact may not be as dramatic because most home buyers may prefer to wait for a more favorable market than selling at a loss, but if their home is sitting in the market for several weeks/months, they may lower the price just to make the sale happen.

For buyers, it’s important to consider their financial profile and needs before joining the market just to benefit from low interest rates. For example, when there are so many buyers seeking out mortgages, a good credit score may not be enough to land prime rates. Similarly, banks may place more stringent down payment requirements, and instead of 10%, you may have to put down 20% of the property price to get a mortgage.

A low interest rate may result in a lower monthly mortgage payment, making it easier for you to pass a mortgage lender’s/bank’s Debt-to-Income (DTI) ratio requirement. Banks use this ratio to determine whether or not the mortgage will make a healthy portion of your monthly income. But in markets like New York City, there is another DTI check that potential buyers need to pass if they are buying a co-op apartment. A co-op board may place a more stringent DTI requirement that may prevent you from buying your desired property, even if you are approved for a mortgage.

For Sellers

For sellers, interest rates influence the market in a different way. When interest rates are high, they may throttle market activity, and with fewer buyers, your chances of selling at the desired price may slump. In contrast, if the interest rates are low, you may have to deal with a bidding war, and with multiple buyers, you can sell at a desired or even a slightly higher price. You can also save money in other ways, like selling the property as-is instead of making repairs after inspection or leaving credit in escrow.

However, just like a buyer’s financial profile, your property’s fundamental merit may influence its desirability more than a macro-factor like interest rate. For example, if your property is in a highly desirable location/building, you can sell at the asking price and fast, even if there are only a few buyers in the market. But if you are selling a fixer-upper, you may have a good chance of getting a good price if you wait for a seller’s market.

Final Words

Interest rates are an important factor that can influence not just your buying/selling process but the market as a whole. But in the end, it’s just one factor. A low interest rate may not always trigger a seller’s market (by initiating a buying frenzy), especially if the economy is weak and there is a shortage of qualified buyers. Factors like the brewing work-from-home culture can influence a desirability shift from urban centers to suburbs.

When people have to commute to work, they prefer buying or renting properties closer to work, increasing their desirability and, consequently, prices. But when most people are working from home, properties in the suburbs may experience a price increase because people may consider moving there for peace and quiet.

Understanding the influence of interest rates on real estate transactions and decisions should give you an appreciation of how complex the real estate market can be and how many variables you should consider if you desire to make an informed decision. But even if you are conducting your own thorough research, it’s always recommended to work with an experienced agent who understands the local market well, especially if you are buying or selling in a complex market like NYC.