People have been talking about higher mortgage interest rates for years.

I like to say that I predicted 4 out of the last 0 mortgage rate increases so I don’t even try to predict mortgage rate increases anymore. To me it seems crazy that they’ve been so low for so long. I would have never predicted it.

BUT… the consensus this morning seems to be that the Fed will increase the Federal Funds rate in December. I’m seeing numbers like 75% to 80% expect a rate increase in December.

Now, just because the Fed rate increases by a quarter-point does NOT mean mortgage rates will increase by a similar amount or that they will increase at all. But they tend to move in the same direction.

Okay, to get a feel for what an increase in the Fed rate might do to home sale prices, let’s look at history.

Fed Rate vs. 30-Year Fixed Mortgage Rate

First, let’s look at the Effective Federal Funds rate compared to the 30-year fixed mortgage rate.

You can see that they kinda move together but it’s real loosey-goosey.

Notice the small increase in the Federal Funds rate in 2016 didn’t cause mortgage rates to increase. Mortgage rates actually FELL in 2016. (I did NOT expect that!)

30-Year Fixed Mortgage Rate vs. Number of Homes Sold

Let’s say a small increase in the Federal Funds rate in December does cause a small increase in mortgage rates.

What happens to the number of homes sold and prices?

You can see a pretty close relationship between mortgage rates and the number of homes sold.

  • After rates increased sharply from late-1993 to late-1994, homes sales fell from mid-1994 to mid-1995.
  • After rates increased sharply in 1999, home sales which had been rising rapidly, leveled off in 2000.
  • And, of course, as rates fell 3 percentage points from 2000 to 2003, home sales took off after a lag.
  • More recently, a 1 percentage point increase in rates in 2013 caused the number of homes sold to fall in 2014.

I don’t normally like to look at national numbers because they dilute what’s happening in individual cities. But this relationship between rates and home sales is so strong, it even shows up in the national data.

So what happens if the Fed increases the Federal Funds rate 0.25% AND the 30-year mortgage rate also goes up 0.25%?

My guess this morning is that U.S. home sales would continue their leveling-off trend. A 0.25% increase wouldn’t be enough to cause home sales to fall but it would undercut the little remaining upward momentum in home sales.

Number of Homes Sold vs. Home Prices

But most people don’t really care about the number of homes sold, they only care about the prices of those homes sold.

You can see the relationship between mortgage rates and home prices is not at all tight.

Sticky. Home prices are famously “sticky.” Home sales have to tank for a long while before prices start to fall.

Looking at the graph above, the number of homes sold peaked in 2005 and then started to tank, but nationally prices didn’t start to fall until 2 years later. That’s the definition of sticky prices.

And you can see in the 1990s that home prices didn’t really respond much to changes in home sales.

Home prices on the upside are also sticky, although not as sticky as on the downside.

The most powerful force in the universe. I think home prices are set more by inertia than by the number of home sales month to month.

If for the last few years home prices have been increasing at a certain rate (or increasing at an increasing rate), people expect them to continue like that. People are willing to pay those expected prices.

Home sales have to be running high for many months or a year or more before the high home sales nudge up the trajectory of home prices.

Ditto in reverse for low home sales. It takes a lot of months of low sales to lower the trajectory of home prices, especially nationally.

Takeaway

If the Fed increases the Federal Funds rate 0.25% AND the 30-year mortgage rate also goes up ~0.25%, the number of U.S. homes that are sold will continue leveling off.

Home prices? Inertia is the most powerful force so home prices will likely continue increasing like they have.

Eventually, when the economy stops growing so fast or it starts to contract, the number of homes sold will fall and prices will stop increasing. Prices won’t start falling unless sales fall for a year or two. Downward sticky prices.

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Note: I’ll update these graphs in the future but, obviously, as I write this post in October 2017 I can only see the data through September 2017.