House Prices Vs. Interest Rates: Which Are More Important?

As you go through the process of buying a house, you’ll come to realize that there are a variety of different factors that make up a given home’s level of affordability. It’s not just asking price, but also type of home loan, interest rate, taxes, cost to maintain the home and any other expenses associated with purchasing and living in the house.

While a home might be within your price range at first glance, these additional factors could actually push it out of the range of what’s affordable for you. This is especially true when it comes to your mortgage interest rate.

How exactly do home prices and mortgage rates interact, and is one of these factors more influential than the other? Let’s take a look at what home buyers should know.

How Do House Prices And Interest Rates Impact Home Buyers?

House prices and interest rates directly impact down payment amounts and monthly payment amounts. Let’s take a closer look at how these factors affect home buyers.

Down Payment

Most home buyers who use a mortgage loan to finance their purchase will need to put down a certain percentage of the sale price.

The standard is 20% down if you’re looking to avoid private mortgage insurance; however, the median down payment for U.S. buyers is 13%, according to the National Association of REALTORS®. On a conventional loan, it’s possible to go as low as 3%.

When considering how much home you can afford, it’s important to think about how much cash you have available to put down. If you put 13% down on a home that costs $200,000, you’ll need $26,000 to close on the home. If that house costs $250,000, you’ll need $32,500.

Monthly Payment

Both the price of the home and the rate on your mortgage will affect the size of your monthly mortgage payments.

Excluding taxes and insurance, your monthly mortgage payment is made up of two basic elements: principal and interest. Principal is the initial amount you borrowed, and interest is the amount you’re charged for borrowing that money.

It might seem obvious how the price of a home will impact the amount you pay each month, but you may not realize how much your mortgage interest rate can impact this as well.

Say you get a 30-year fixed-rate mortgage for $200,000 with an interest rate of 4%. Your monthly payment will be about $955. Contrast this with a $200,000 loan at 3.5%, with which you’ll have a monthly payment of roughly $898. That’s a $57 difference each month.

Over 30 years, you’ll have paid your lender an additional $143,739 in interest on the 4% loan, and only $123,312 on the 3.5% loan.

Historical Mortgage Rates Vs. Home Prices

Not only did the Great Recession drastically impact interest rates, but more recently in 2020, COVID-19 directly impacted the housing market.

During an economic downturn, home prices may go down and the Federal Reserve might decide to lower interest rates to stimulate economic growth. This can be an ideal environment for a hopeful home buyer, but if you’re struggling with unemployment due to a down economy, you probably won’t be able to take advantage of it.

It’s worth noting that 2020 was an exception to the recession rule because home prices went up given low interest rates and the fact that people realized their current space didn’t fit their pandemic lifestyle.

Let’s take a closer look at the average interest rate for 30-year fixed-rate mortgages.

House Prices Vs. Interest Rates: Example Scenario

Is there any correlation between mortgage interest rates and home prices? If one goes up, does the other go down?

Low interest rates can increase demand for homes, while high interest rates can slow demand. When demand for homes goes up, prices tend to follow suit.

However, there isn’t always a perfect correlation. In practice, there are many different factors that affect home prices and mortgage rates, including local market conditions and larger economic trends.

Which environment is better for home buyers? Consider the following example.

When Janet originally bought her house, it was worth $250,000. She made a 10% down payment, so she paid $25,000 out of pocket and financed the remaining $225,000 at an interest rate of 6%. She pays around $1,349 each month for her mortgage. If she were to keep her house for the entire duration of her 30-year mortgage, she’d pay $260,636 in interest.

Janet has decided, however, that now is the time to sell her home. Because home values have increased since she purchased her home, her buyer, Joe, plans to purchase the home for $300,000. Joe also decides to put down a 10% down payment, meaning he’ll pay $30,000 in cash at the closing table and will take out a $270,000 mortgage to pay the rest. Joe’s mortgage lender approves him for a 4% interest rate.

Despite paying more for the house than Janet, Joe’s monthly payment will be $1,289, and he’ll only pay $194,048 in interest over the life of the loan, thanks to his lower interest rate.

As we can see, interest rates can make a huge difference in a given home’s affordability. However, that doesn’t mean that you should sit around waiting for rates to go down before you buy a house.

It’s also possible for a lower-priced house in a high-rate environment to be more affordable than a higher-priced house in a low-rate environment; it just depends on how the math shakes out.

Advantages Of Lower House Prices

Most hopeful home buyers dream of low prices – but what if that means taking on a higher interest rate? Which is preferable?

The immediate advantage of buying a home on the lower end of your price range is that you won’t need to bring as much cash to the table for your down payment.

If homes are more affordable because interest rates are high, buying a lower-priced home could work to your advantage in the long run if you think rates will eventually go down. Once mortgage rates drop, you may have the option to refinance into a new loan at the lower rate.

Advantages Of Lower Interest Rates

Of course, having a low interest rate right out of the gate is likely going to be better for you than having to wait for rates to drop and then go through the refinance process. But is a lower interest rate worth a higher price tag?

In addition to lowering the amount of money you’ll pay to borrow the mortgage, low interest rates can give a small boost to your buying power, since a smaller portion of your monthly payment will go toward interest. This can mean being able to afford a little bit more house than you might in a higher rate environment.

House Prices Vs. Interest Rates FAQs

Now that we’ve touched on the basics, let’s run through the questions you might have.

What’s a good interest rate on a house?

A good interest rate is commonly 6% – 7% on a 30-year fixed as of this writing in October 2022. It’s important to consider that the interest rate to buy a house not only depends on the current market, but also your own financial situation such as your credit score, debt-to-income ratio, your down payment and more.

Different lenders offer different products and services, so it’s always helpful to shop around and compare quotes during your house hunt or refinance process.

Can there be low prices and low rates at the same time?

It is possible for prices and rates to go down simultaneously – this happened during the Great Recession and for a short time after while the economy began to recover.

Because home prices are also dependent on where you plan to live and what the housing market looks like in that area, including whether you’re in a buyer’s market or a seller’s market, it’s hard to say whether you’ll encounter low prices and low rates at the same time, regardless of what the larger economy is doing.

How long should you wait for either to drop?

Predicting which way the real estate market will move is tough even for the experts. While it might be tempting to wait for home prices to go down or the Fed to announce a rate drop, there’s no guarantee that your efforts will pay off.

If you aren’t in a rush to buy a home, you can always take a “wait and see” approach, but keep in mind that while prices or rates could drop, they could also stay the same or even go up.

Will mortgage points get me a lower interest rate?

Mortgage points, also called discount points, offer borrowers the opportunity to pay an extra fee during the closing process to lock in a lower interest rate. Home buyers can purchase mortgage points to lock in a lower refinance rate or when buying a new house.

Although, mortgage points aren’t for everyone since it increases your closing costs. The longer you plan on owning your home, the more points can help you save on interest over the life of the loan.

The Bottom Line

Ultimately, the best time to buy a house is when you feel you’re ready to do so.

Though there are benefits to both low rate and low-price environments, it’s hard to time the market to your advantage. Doing so could potentially mean buying before you’re ready or waiting too long and missing out on a great opportunity.

Keep an eye on rates and prices, but also work on readying your finances for homeownership: saving for a down payment, building up your credit score and paying down any debt you owe.

Ready to get started on your house hunt? Start the mortgage approval process today! You can also give us a call at (888) 452-0335.