The interest rate on your mortgage will depend on several factors — some that you can control and some you can’t. For example, you can work on increasing your credit score to get the best possible rate, but there’s not much you can do about market conditions when interest rates are high.
Some first-time homebuyers wonder if they should hold off until interest rates drop — which can be a letdown for those who had their heart set on homeownership in the near future. But the truth is, there are both pros and cons to buying a home when interest rates are high. We’ll walk you through what you need to know to make an informed decision.
How Do Mortgage Interest Rates Work?
Your mortgage interest rate is the amount of money it costs per year to borrow your home loan, and it’s expressed as a percentage rate. To determine what interest rate you’ll be charged, mortgage lenders will consider various personal financial factors — like your credit score and the size of your down payment. However, your mortgage interest rate will also be affected by current market conditions.
So, what affects mortgage rates? The Federal Reserve is the central bank of the United States, and it influences interest rates as a way to keep the economy healthy. While the Fed doesn’t directly manipulate mortgage interest rates, it does set the federal funds rate — which is how much banks must pay to conduct daily business. The Fed can either lower the federal funds rate to make it easier to borrow money, or raise its target rate to reel in borrowing and keep prices down.
How interest rates affect home prices
A higher interest rate means you’ll pay more for your mortgage — but not necessarily the home itself. That’s because when interest rates go up, fewer people can afford expensive homes because they’re already paying more in interest. As a result, home prices tend to drop when interest rates go up.
In 2023, the Fed has increased interest rates several times to tame inflation. These mortgage rates seemed high compared to the record-low interest rates seen in 2020. But compared to 1981, when the average interest rate for a 30-year fixed-rate mortgage hit 18.63%, today’s rate is relatively low.
Here’s a comparison between average interest rates over the years to give you a better idea of how current interest rates compare:
Interest Rates and Home Prices
|Year||Average Interest Rates||Median Home Sale Price|
Pros of Buying a Home When Interest Rates Are High
Some people assume that there’s no upside to making a home purchase when interest rates are higher than usual — but that’s not necessarily true. Here’s a look at some advantages of buying a home when interest rates are high.
Home prices are lower
When interest rates are high, some potential homebuyers pause their search, which results in less competition. When demand drops, it results in a buyer’s market — where buyers have more leverage and sellers tend to lower their prices. So, while you may be paying more in interest, you might be able to score a better deal on the house itself.
There’s less risk for buyers
Another benefit to a buyer’s market is that it gives the buyer more power to negotiate. Certain conditions — known as contingencies — protect buyers and can be built into the purchase agreement. If these contingencies aren’t met, the buyer is able to back out of the deal without losing their earnest money deposit.
Sellers don’t typically want offers with too many contingencies because it increases the chance that the deal will fall through. But when interest rates are high, the buyer has more negotiating power and can ask for more contingencies.
“As interest rates have increased, we would expect to see some sellers that may need to sell rather quickly, which should open up some better buying opportunities,” says Chad Gallagher, co-founder and head of growth and investments at Home365, a property management company in Lancaster, Pennsylvania.
Cons of Buying a Home When Interest Rates Are High
Higher interest rates aren’t the most ideal conditions for prospective homebuyers. Here are some of the downsides to buying a home when interest rates are high.
Higher monthly payments
Even if you have a stellar credit score to buy a house, you’re going to have to pay more for your mortgage if you take out a loan when interest rates are high. This is because of the higher monthly payments.
Less borrowing power
Higher interest rates affect the mortgage you can afford. Your lender will need to confirm that you can afford your home loan and keep up with your monthly payments. As interest rates increase, the amount of money you can borrow decreases. As a result, you may not be able to afford the same price range of homes as you would with a lower interest rate.
You could get priced out of the market
Higher interest rates also mean you might not be able to afford a home in the current market because you’ll have to pay more each month. This makes buying a home less attainable for low- and moderate-income buyers.
The Risks of Trying To Time the Mortgage Market
When interest rates are high, some prospective homebuyers hold off on buying right away and instead wait it out until interest rates drop. The problem is, there’s no guarantee that interest rates will drop. In fact, interest rates could increase. Not only would you be delaying your homeownership goals, but you could also end up paying even more for your mortgage.
“It is incredibly difficult to gauge what future mortgage rates will look like,” Gallagher says. “Who would have ever guessed that mortgage rates would decline for 40 years?”
FAQ: Should You Buy When Interest Rates Are High?
Here are the answers to some frequently asked questions about buying a home when interest rates are high.